US Market: Rising R-star adds to pressure on US Treasury yields as AI investment, borrowing lift demand for capital

A recent rise in US Treasury yields is partly reflecting growing investor expectations that a little-known measure of the economy's neutral interest rate, known as R-star, may be moving higher, according to a report by Reuters.

R-star refers to the theoretical interest rate that neither stimulates nor restrains economic activity when the economy is operating at full potential. Some analysts believe it could be higher than recent estimates suggest as the US economy absorbs a powerful combination of artificial intelligence-related investment and heavy government borrowing.

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A higher R-star would imply that interest rates could remain structurally elevated, putting additional pressure on bond prices. However, analysts say it is difficult to determine an exact level because the measure varies depending on the methodology used and is based on historical economic data.

According to Reuters, analysts point to the surge in AI-related capital spending and elevated US government debt as potential factors pushing demand for capital higher and lifting real yields.

The debate has significant implications for financial markets. If R-star is structurally higher, interest rates may remain higher for longer, affecting everything from mortgage costs and corporate borrowing to the government's cost of servicing its debt. It could also make it more difficult for the Federal Reserve to cut interest rates aggressively, even as bond markets come under pressure.

Christopher Waller said on Thursday that he was likely to raise his estimate of the neutral rate, citing the lack of additional compensation investors receive for holding Treasuries amid concerns over the US fiscal outlook.

Estimating the elusive neutral rate

R-star has long been used by economists to assess whether monetary policy is restrictive or accommodative. But the measure is notoriously difficult to estimate because results can vary depending on the economic model and the time period examined.

The New York Federal Reserve's latest estimates from its widely followed Laubach-Williams model put R-star at 1.65% in the second quarter of 2026, down slightly from 1.73% in the first quarter. Despite the recent decline, the measure has risen from 1.36% in the first quarter of 2025.

Market participants believe the current neutral rate could be higher as hyperscalers such as Amazon, Microsoft and Google's parent Alphabet ramp up spending and borrowing to finance AI infrastructure, while the US government continues to issue large amounts of debt.

The report stated that analysts see the combination of strong private-sector investment and heavy public-sector borrowing as increasing competition for available capital and putting upward pressure on real yields.

Yield curve faces upward pressure

A structural rise in R-star could push two- and five-year Treasury yields higher because it would imply that the Federal Reserve may ultimately need to maintain a higher policy rate.

Longer-term yields face additional pressure from rising expectations for future policy rates as well as an increase in the term premium, or the extra compensation investors demand for holding longer-duration government debt.

The 30-year Treasury yield could be particularly sensitive to these forces. Elevated US debt levels and persistent fiscal deficits increase the amount of long-term borrowing that needs to be absorbed by investors, potentially amplifying upward pressure on yields.

AI boom fuels demand for capital

The surge in AI investment is adding another source of demand for financing. Large technology companies and cloud providers are investing heavily in data centres and other infrastructure, with some turning to bond markets to fund the expansion.

The growing supply of corporate debt could compete with long-dated Treasuries for investor capital, potentially lifting long-term borrowing costs and contributing to a higher neutral rate.

The report stated, however, that the impact of AI on R-star may not necessarily be permanent. If AI-driven productivity gains eventually prove strongly disinflationary, the technology boom could ultimately reduce inflationary pressures and allow interest rates to fall over the longer term.

For now, the near-term effect may be the opposite, with massive investment requirements increasing demand for capital and keeping the neutral rate elevated.

At the same time, the US government continues to borrow heavily, with national debt reaching $40 trillion. The combination of substantial public-sector borrowing and a surge in private-sector investment represents an unusual increase in demand for capital that could keep the neutral rate elevated even if the Federal Reserve remains on hold.

Productivity could provide another boost

A higher R-star could also reflect stronger underlying productivity and economic growth. The neutral rate is influenced by the economy's long-term growth potential as well as inflation, meaning an increase in trend growth could translate into a higher R-star.

However, economists caution that it is too early to determine whether the recent investment boom represents a lasting structural shift or a temporary phase.

Determining whether the increase in AI-related spending marks a fundamental change in the economy will require years of economic data. Until then, uncertainty around the neutral rate is likely to remain an important consideration for investors assessing the future path of Treasury yields and Federal Reserve policy.