Federal Reserve: The attractiveness of government bonds is declining, driving key interest rates up

Researchers at the New York Federal Reserve have indicated that a key global interest rate is rising, primarily due to a decline in the attractiveness of government bonds in terms of safety and liquidity.

The so-called "natural rate of interest"—the short-term interest rate when the economy is at full employment and inflation is stable—has shown a "statistically significant increase" since 2019. Researchers at the New York Fed stated in a blog post that the natural rate of interest in the United States and other developed economies has risen by about 1 percentage point.

The researchers noted that while there are other factors driving the rise in interest rates, the waning interest of investors in government bonds as a safe asset may account for as much as half of the increase in the natural rate. This can be seen in the narrowing of the spread on U.S. corporate bonds. This change has various causes, potentially including the surge in government debt in developed economies.

Although the natural rate of interest is merely a theoretical concept (often referred to as r-star in economic analysis), it is important because it influences central banks' decisions when setting market interest rates. Federal Reserve Chairman Jerome Powell described the natural rate as an important star that sailors rely on when navigating at the annual central bank symposium held in Jackson Hole, Wyoming, in 2018.

The New York Fed's article noted that statistical analysis shows a significant increase in the natural rate of interest in the U.S. and its global counterparts during the post-COVID period. In the preceding period (from 1990 to 2019), "investor preference for safety (and liquidity) drove yields on government bonds in developed economies to decline continuously," which can be said to have also contributed to the downward trend in the neutral rate.

The researchers also stated that other potential factors driving interest rates up in the post-pandemic era include: prospects for productivity growth driven by artificial intelligence. Additionally, in economies facing demographic transitions, the debt-to-GDP ratio may rise, and expectations for higher military spending may also be one of the reasons pushing up the natural rate, or both factors may be at play