ECB and Fed policymakers have recently made frequent references to the neutral rate,1 or r*, confirming that central banks consider it to be a guide for interest rate policy. To understand cross-market differences in longer-term bond yields and yield curves – and to identify investment opportunities – it is therefore crucial to have a view on r*. The complication is that it is a theoretical concept. For each market, estimates of r* depend on assumptions about a whole host of variables, including inflation, growth, fiscal prudence and demographics.
Our r* estimates are below those of the market. While we agree with the view that an easier post-pandemic fiscal stance may be a factor in halting the secular downtrend in the neutral rate, our view is that demographic shifts could keep it low by historical standards over the next five to ten years. This is particularly true for advanced economies.
We have a bias for developed market policy rates to reverse somewhat quicker towards our below-market estimates of r* over the coming years. Hence, we are in the process of turning constructive on 5 to 10-year government bonds.
Figure 1 | Long-run nominal r* estimates vs. market proxy
Source: Bloomberg, Federal Reserve, ECB, BoE, BoJ, BIS, Robeco
** 5y OIS 5y forward, except for China & South Korea (5y5y IRS) & Brazil (5y5y sovereign yield)
Footnote
1 The neutral rate, also referred to as ‘r-star’, is the long-run equilibrium interest rate. It is the rate at which the economy is at full employment and inflation is stable. Central bank policy is neither contractionary nor expansionary at this level of interest rate
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