United States: Low investment concerns caused by rising real interest rates
2025-05-29
■ In the US Treasury market, ultra-long Treasury yields and short- to medium-term breakeven inflation rates continue to rise.
■ Rising long- and ultra-long real interest rates have contributed to low investment, becoming the underlying cause of declining potential growth and structural inflation.
In the US Treasury market, there are concerns about tax cuts that lack a permanent fiscal funding source. Last week, long- and ultra-long Treasury yields increased as the market factored in the heightened fiscal risk premiums. The yield curve has further steepened, with the US 30-year Treasury yield reaching approximately 5.16% on May 22, close to the recent high in October 2023.
The expected inflation rate embedded in inflation-protected bonds has diverged significantly across maturities due to tariffs since the US presidential election in November last year. Prior to the presidential election, the breakeven inflation rate (BEI) for each maturity remained fairly stable at just over 2%. According to the latest data at the time of writing, as of May 27, the 10-year and above maturities (10 years: 2.33%, 30 years: 2.30%) stabilized around 2.3%, while the 2-year and below maturities (1 year: 2.92%, 2 years: 2.68%) have risen sharply since last November. In the U.S. Treasury market, although the high inflation expectations for the next two years have been factored in due to the tariff increase, the market believes that the effects of the tariffs are difficult to sustain and have little impact on medium- and long-term inflation expectations. Contrary to the findings of the Conference Board and the University of Michigan consumer survey, which indicate that consumers expect inflation to accelerate in the medium and long term, the Treasury market's response supports the Federal Reserve's (FRB) view of stable medium- and long-term inflation expectations.
Affected by the U.S. tariff policy, the real interest rate derived by excluding the expected inflation rate from the yield of Treasury bonds of the same maturity has declined in the medium and short term (2 years or less), while it has risen sharply in the ultra-long term (10 years or more), further widening the gap in real interest rates across various maturities. The financing cost is determined by the nominal benchmark interest rate plus an additional risk premium. Enterprises and households can make investment decisions based on future inflation expectations. Therefore, in theory, the cost of economic activities in the real economy should be informed by the real interest rate. Particularly in the field of equipment and residential investment, which are made with a long-term perspective, the impact of the real interest rate is significant. The rise in long-term and ultra-long-term real interest rates will diminish the profitability of investment plans and inhibit investment. Investment acts as both a demand item and, through the accumulation of capital stock, also embodies characteristics of a future supply item. Should corporate investment be insufficient due to trade policy uncertainty and increasing real interest rates, future supply capacity will be restricted, leading to a corresponding decline in potential growth rates. If the supply capacity structurally falls beneath the demand level, economic supply and demand will tighten, potentially triggering medium- and long-term inflation acceleration not reflected in the current BEI.
■ Rising long- and ultra-long real interest rates have contributed to low investment, becoming the underlying cause of declining potential growth and structural inflation.
In the US Treasury market, there are concerns about tax cuts that lack a permanent fiscal funding source. Last week, long- and ultra-long Treasury yields increased as the market factored in the heightened fiscal risk premiums. The yield curve has further steepened, with the US 30-year Treasury yield reaching approximately 5.16% on May 22, close to the recent high in October 2023.
The expected inflation rate embedded in inflation-protected bonds has diverged significantly across maturities due to tariffs since the US presidential election in November last year. Prior to the presidential election, the breakeven inflation rate (BEI) for each maturity remained fairly stable at just over 2%. According to the latest data at the time of writing, as of May 27, the 10-year and above maturities (10 years: 2.33%, 30 years: 2.30%) stabilized around 2.3%, while the 2-year and below maturities (1 year: 2.92%, 2 years: 2.68%) have risen sharply since last November. In the U.S. Treasury market, although the high inflation expectations for the next two years have been factored in due to the tariff increase, the market believes that the effects of the tariffs are difficult to sustain and have little impact on medium- and long-term inflation expectations. Contrary to the findings of the Conference Board and the University of Michigan consumer survey, which indicate that consumers expect inflation to accelerate in the medium and long term, the Treasury market's response supports the Federal Reserve's (FRB) view of stable medium- and long-term inflation expectations.
Affected by the U.S. tariff policy, the real interest rate derived by excluding the expected inflation rate from the yield of Treasury bonds of the same maturity has declined in the medium and short term (2 years or less), while it has risen sharply in the ultra-long term (10 years or more), further widening the gap in real interest rates across various maturities. The financing cost is determined by the nominal benchmark interest rate plus an additional risk premium. Enterprises and households can make investment decisions based on future inflation expectations. Therefore, in theory, the cost of economic activities in the real economy should be informed by the real interest rate. Particularly in the field of equipment and residential investment, which are made with a long-term perspective, the impact of the real interest rate is significant. The rise in long-term and ultra-long-term real interest rates will diminish the profitability of investment plans and inhibit investment. Investment acts as both a demand item and, through the accumulation of capital stock, also embodies characteristics of a future supply item. Should corporate investment be insufficient due to trade policy uncertainty and increasing real interest rates, future supply capacity will be restricted, leading to a corresponding decline in potential growth rates. If the supply capacity structurally falls beneath the demand level, economic supply and demand will tighten, potentially triggering medium- and long-term inflation acceleration not reflected in the current BEI.