Key facts
- New York Fed President John Williams stated rising bond yields reflect a strong U.S. economy and positive outlook.
- Williams attributed economic strength to significant investments in artificial intelligence, data centers, and technology.
- The Fed's Beige Book reported U.S. economic activity increased modestly, employment rose slightly, and prices increased moderately.
- Analysts suggest that a theoretical rate consistent with stable growth and inflation (R-star) may be rising due to AI investment and government borrowing.
- A higher R-star could imply structurally elevated interest rates, impacting borrowing costs and the Fed's rate-cutting path.
New York Fed President John Williams stated that rising Treasury yields are primarily a reflection of a strong U.S. economy and its positive outlook, rather than fears of inflation. He attributed this economic strength to significant investments in artificial intelligence, data centers, and technology.
Williams' comments come as analysts debate whether an obscure, theoretical rate known as R-star, which represents the rate consistent with stable growth and inflation, might be moving higher. This potential increase is linked to substantial capital spending on AI infrastructure and heavy government borrowing. If R-star is indeed rising, it suggests that interest rates may settle at structurally elevated levels, which could complicate the Federal Reserve's path to cutting rates and increase borrowing costs across the economy.
The Federal Reserve's latest Beige Book report indicated that U.S. economic activity increased modestly, employment rose slightly, and prices increased moderately, with some sectors showing slowing price increases due to customer price sensitivity. Williams emphasized that the Fed is still gathering data to inform its policy decisions, focusing on returning inflation to its 2% target.
Estimating R-star is notoriously difficult, with different models yielding varying results. The New York Fed's own Laubach-Williams model shows R-star trending higher since early 2025. Analysts like Chip Hughey of Truist Wealth suggest that AI investments and higher government debt levels are boosting demand for capital and lifting real yields. Zachary Griffiths of CreditSights noted that a structural increase in R-star is putting upward pressure on various parts of the yield curve, including the 10-year yield, due to expectations of higher policy rates and a demand for a larger term premium.