With all the recent hullabaloo about the 10-year UST yield breaking 3%, I found this recent letter from SF Fed President, John Williams, very fair and balanced.
For readers that aren’t familiar with the concept of the natural rate of interest, it’s simply the real interest rate (nominal or published rate less inflation) expected to prevail when the economy is at full strength. In other words, when GDP growth is at its trend rate and inflation is stable. It’s a longer-term interest rate and isn’t set by a central bank. Longer-term economic factors drive the natural rate of interest.
In the letter, the author contends that the natural rate of interest is likely to remain low for quite some time due to the following three factors:
- Demographics: Primarily longer lifespans and the propensity to save
- Slower productivity growth
- Continued demand for safe assets
It’s always a good idea to reset one’s bearings after a flurry of short-term market moves and commentary. Interest rates may be volatile right now and in an uptrend but it doesn’t seem like all the factors are there to drive them meaningfully higher on a sustained basis. If anything, higher inflation may push nominal rates higher, but the drivers for real rates appear to remain fairly subdued for the time being. Inflation may be the key to interest rate trends for the foreseeable future.
