“Standard theory predicts that risk-free real rates **decline** when we expect higher economic growth as some of us try to consume some of that extra future income today by borrowing, thus pushing up rates.”
Is this a typo - or am I just ready for the weekend?
The embedded AI productivity bet in the long end of the curve is a framing I haven't seen stated quite this directly before, and it actually resolves something that's been puzzling about why 10-year yields haven't moved more given the fiscal trajectory.
Unfortunately, in addition to the typo already noted by Alex, you bury a very important aspect in the "fine print."
Yes, the automatic stabilizer implies a better fiscal position from higher (productivity- or other driven) growth, and hence will put downward pressure on govvy bond yields.
At the same time, though, higher growth will raise the equilibrium/"neutral" real rate, as you allow for in your calculations.
All fine, and very clearly stated.
What is not so fine, though, is using the fiscal argument to support Warsh's statement (as far as I understood it--it is never really clear with him...) that an AI boom would permit the Fed to lower its rates; no, the Fed is not in the business of tracking long-duration risk-free bonds, but to set its policy rate with reference to the real equilibrium rate, which will c.p. rise with higher productivity growth.
Hence, I think your argument supports a "bull flattening" curve, which may well not imply lower FedFunds, contrary to what Warsh seems to claim.
“Standard theory predicts that risk-free real rates **decline** when we expect higher economic growth as some of us try to consume some of that extra future income today by borrowing, thus pushing up rates.”
Is this a typo - or am I just ready for the weekend?
That was avery bad typo. :( Thanks, Alex!!
“If markets fully priced this in, nominal Treasury yields would fall by about 70 basis points.”
Er… how can you say this, without knowing approximately how much it already has priced this in??
The embedded AI productivity bet in the long end of the curve is a framing I haven't seen stated quite this directly before, and it actually resolves something that's been puzzling about why 10-year yields haven't moved more given the fiscal trajectory.
Another excellent piece!
Unfortunately, in addition to the typo already noted by Alex, you bury a very important aspect in the "fine print."
Yes, the automatic stabilizer implies a better fiscal position from higher (productivity- or other driven) growth, and hence will put downward pressure on govvy bond yields.
At the same time, though, higher growth will raise the equilibrium/"neutral" real rate, as you allow for in your calculations.
All fine, and very clearly stated.
What is not so fine, though, is using the fiscal argument to support Warsh's statement (as far as I understood it--it is never really clear with him...) that an AI boom would permit the Fed to lower its rates; no, the Fed is not in the business of tracking long-duration risk-free bonds, but to set its policy rate with reference to the real equilibrium rate, which will c.p. rise with higher productivity growth.
Hence, I think your argument supports a "bull flattening" curve, which may well not imply lower FedFunds, contrary to what Warsh seems to claim.