The Impact of Artificial Intelligence on Bond Yields and Interest Rates: A Deep Dive

The Impact of Artificial Intelligence on Bond Yields and Interest Rates

Artificial Intelligence (AI) has been a hot topic in the market, with a focus on its potential impact on productivity gains and equity markets. However, a new study suggests that AI could also have significant implications for fixed income markets, particularly in relation to interest rates and bond yields.

The conventional view on the impact of AI on rates is that if productivity increases due to AI, the demand for capital will also increase, driving real interest rates and government bond yields higher. This could lead to an increase in equilibrium real interest rates, or the Fed’s R-star, which is the rate at which inflation is at target and the economy is at full employment.

Historical data shows that during the Goldilocks era from the 1990s to 2007, US nominal yields were around 5-6% during periods of faster productivity growth. However, in the post-Covid era, there are parallels with Goldilocks but also distinct differences, such as slower productivity growth and low yields.

The long period of weak productivity growth from 2007-2020 has been attributed to zero rates “zombifying” economies, pushing the cost of capital below the marginal product of capital and distorting the allocation of capital. This has led to low yields and stagnant productivity growth in many economies.

The impact of AI on the labor market is also a key consideration, as the displacement effect of AI on jobs could lead to higher unemployment initially, which may affect domestic demand and inflation. This could result in a recession and lower interest rates in the short term, but higher rates and yields in the long term.

Overall, the study suggests that AI could drive steeper yield curves in the medium term, but the current trend of flat or inverted yield curves continues to dominate fixed income markets. The differences between the Goldilocks era and the post-Covid era, such as aging demographics and higher debt levels, will also play a role in shaping bond yields and interest rates in the future.

In conclusion, the impact of AI on bond yields and interest rates is complex and multifaceted, with structural crosscurrents influencing the global market. As AI continues to evolve and shape the economy, it will be important to monitor how these trends impact fixed income markets in the years to come.