The two speeches by Mark Carney and Isabel Schnabel this month may turn out to mark a pivotal turning point in markets. The narrative that real rates may shift upwards due to the investment required clean energy is gaining traction.
It is important to put the thesis of rising r* into context. Deflated by the CPI, the real 10-year US government bond yield was at a record low of -5.94% in February, even lower than the inflation era of the 70s, including the twin ‘peaks’ of December 1974 and March 1980. In this sense, it is not that hard to argue for a rise in r*.
That said, the shift in investment required to green the global economy makes a compelling case for a rise in both real and nominal rates. With inflation expected to remain higher for longer, the nominal yield on the 10-year US Treasury should continue to climb and could reach 3% by year-end, and push towards 3.5-4.0% by 2023. The FOMC will be forced to revise its estimate of the longer-term Federal funds rate higher too.
To realistically achieve the Paris goals, the investment ‘boom’ will have to start now, during a time of a commodity bull market and accelerating capital goods inflation. Global prices for steel rebar are surging, adding to costs for many renewable energy projects. Prices have already climbed steeply over the past year, delaying, and even cancelling some wind and solar ventures.
Spending to ensure energy, food & water security is going to increase substantially over the coming decade. Other (related) contributing factors to the rise in real rates are the reshoring of domestic production (deglobalisation) and the building of more resilient supply chains.
