If you read the weekly (it’s in your inbox, and it’s also here), you probably noticed the r-star discussion came up again.

I’ve done my best recently to demystify and, more importantly, contextualize, the debate around the long run neutral rate.

This is going to be more topical going forward and, indeed, the recent run of hot US economic data underscores the notion that it’s becoming more urgent virtually by the week, if not by the day.

In the weekly, I quoted Bloomberg’s Cameron Crise, who’s pretty adept at picking up on what’s trending among “serious” macro and market observers by virtue of being a “serious” observer himself. The scare quotes are just a humble acknowledgement that “serious” is a highly relative term in this context. (Am I “serious”? Are you? Is anybody? I don’t know. We’d all like to think so. But then again, we’re biased.)

For anyone who might’ve missed the weekly (maybe you, unlike me, have something better to do on Friday evenings than ponder the vagaries of implied neutral estimates), or for those interested in a bit of additional color, consider the excerpt below from Crise’s piece, which is quite long in its entirety, and covers lots of additional ground:

There has started to be a more public discussion of whether the long-term neutral rate (r-star in real terms) is actually as low as it has been projected over the last few years. It is probably fair to say that the most recent slate of data has been positively impacted by the weather [but] it doesn’t look like the economy as a whole is falling off a cliff… a pretty stunning result given that policy is ostensibly more than 200bps above neutral, and the transmission mechanism into financial markets is virtually instantaneous these days. It’s certainly rational to question whether neutral actually is 2.5% in nominal terms. The market seems to be pricing an increasing probability that it is not; long-term money-market expectations have shifted out of the pattern of the past couple of decades. The 20th eurodollar contract… now implies policy rates of nearly 3.5% in five years — pricing has surged above the Fed’s long-term median by an unprecedented amount. [Although] this isn’t a totally new development, a world where policy rates aren’t even in the same zip code as ZIRP over a full market cycle would represent a very different backdrop than any experienced by those in the mid-30s and younger.

Crise isn’t “old” in any strict sense of the word, so the reference to thirtysomethings is included more for dramatic effect than anything else. I do the same thing habitually, but I’m reminded of August 23, 2018, when, during a EM FX meltdown that coincided with the last Fed hiking cycle, Vincent Cignarella, another market veteran-turned Bloomberg blogger, told terminal users that, “I was trading during the crisis in 1987 while my colleague Cameron’s bike still had training wheels on it.”

But, despite not being 75 years old, Crise does have a point about “higher for longer” rates clashing with psychological dispositions associated with the post-Lehman years, an era I often characterize as “tyranny by acronym,” to describe the implicit asset allocation mandates dictated by ZIRP, NIRP, LSAP and the attendant global dearth of yield.

“It seems reasonable to think that risk premia across many assets — notably equity and credit — don’t reflect the possibility priced into money-market curves,” Crise went on, in the same piece quoted above.

That was Thursday. Fast forward to Friday evening, and Goldman’s rates team revisited the subject for a second straight week, noting that since the November FOMC meeting, “the beta of changes to forward rate pricing 12 months beyond the peak rate to changes in the peak rate has increased” as rate hike premium migrates out the curve.

The bank’s Praveen Korapaty offered two explanations, one of which centered squarely on the topic at hand.

After nodding to the obvious (i.e., that smaller rate hike increments ostensibly lessen the risk of over-tightening and thereby reduce the odds of an abrupt pivot to aggressive easing once terminal is reached), Korapaty noted that “growth outcomes in a high-rate environment are key to investors’ longer term rate anchor [but] they will also have a bearing on how far policy tightening may need to extend (and remain) to cool inflation.”

So, the more robust the US economy’s reinvigorated growth profile proves to be, the more inclined the market is to suspect that r-star is higher, thus “resetting more distant forward rate levels while also raising risks that tightening may have to extend to an even higher peak.”

As Nomura’s Charlie McElligott put it, “what the rates repricing is potentially indicating is the larger structural story that r-star is likely higher than previously realized, which likely then too means the terminal rate needs to move higher.”

But, as Korapaty was keen to suggest, there may be a limit on at least one aspect of this dynamic. “[A] higher beta between forward rate levels beyond terminal and terminal itself can continue for now [but] there are likely limits,” he wrote. “In particular, even at a slower pace of hikes, if it becomes clear that the Fed will have to hike substantially more to bring inflation back under control, we could see a return to a flattening dynamic on the back of a re-intensification of recession concerns.”