Those fiscal concerns are being compounded by a growing supply of long-term debt beyond Treasuries, particularly from AI-driven borrowing by hyperscalers, as massive bond sales compete with longer-dated U.S. Treasuries for investor capital. That has lifted long-term yields and likely elevated the neutral rate, analysts said.
Ulrike Hoffmann-Burchardi, chief investment officer Americas and global head of equities at the UBS Chief Investment Office, however, said that the Fed "cannot easily cut interest rates back to zero when the structural demand for capital remains this high."
Still, some analysts think the tech-driven increase in R-star could be temporary if AI in the long term proves disinflationary.
"In the near term, the impact of AI is going to be a higher R-star before potentially flipping to a lower nominal policy rate in the longer term depending on the disinflationary or even potentially deflationary effects of it," said CreditSights' Griffiths.
But as the AI boom is unfolding, the U.S. government continues to borrow heavily, with the national debt hitting $40 trillion. The result is an unusual combination that shows huge public sector demand for capital occurring alongside a surge in private sector investment. This scenario is likely to keep the neutral rate higher even if the Fed is on an extended pause.
Another reason a higher neutral rate can persist, analysts said, is that it reflects stronger productivity growth, or higher economic growth more broadly. When the Fed thinks about the neutral rate, it considers both the economy's underlying growth rate and inflation. If trend growth rises, R-star is likely to rise as well.
Yet analysts noted that it is far too early to say whether those forces represent a long-lasting change in the economy or a temporary phenomenon.
Economists will need years of data to determine whether the latest investment surge, for instance, represents a structural shift or another cycle that eventually fades, analysts said.
"The Fed is currently trying to assess whether or not we are sufficiently restrictive against a backdrop in which there is a tremendous amount of investment being made in the economy and where there's also big demand for capital coming from the government," said Truist's Hughey.
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