Rising long-term borrowing rates in the United States have sparked concern and uncertainty in financial markets. Despite the Federal Reserve not expected to raise rates again in this cycle, bond yields have been climbing steeply, impacting interest-rate sensitive stocks. This development suggests that the Fed may not be able to ease monetary policy as much as previously assumed. Additionally, the strong performance of the US economy, coupled with positive economic indicators, has led some experts to question whether long-term sustainable interest rates are returning to pre-2008 levels. However, there are also concerns that rising debt and structural shifts may be contributing to higher long-term real interest rates, with implications for economic growth and stability. The situation has prompted discussions about a potential "duration crisis" and the risks it poses to the financial system.
The recent surge in U.S. long-term borrowing rates has caused concern in financial markets, as investors grapple with the implications of rising bond yields. Despite the Federal Reserve’s expected stance of not raising rates in the near future, U.S. Treasury rates have climbed to their highest levels in years. This has led many to question whether the post-pandemic reshaping of economies is driving sustainable interest rates back to pre-2008 levels. On one hand, the strong performance of the U.S. economy and the potential for rising trend growth are positive indicators. On the other hand, rising debt levels and structural shifts may be contributing to higher interest rates. Additionally, the increase in deficits and the reduction in demand for Treasuries from emerging market central banks could further push up long-term bond yields.
The rise in long-term borrowing rates could have both positive and negative implications. On the positive side, higher interest rates for longer periods could be beneficial for corporate earnings potential and investment. The strong economic data, including retail sales, industrial output, and housing starts, have led to upward revisions in U.S. gross domestic product forecasts. However, a more negative take suggests that the increase in the theoretical long-term real interest rate, known as the ‘R-star’ variable, may be driven by rising debt and structural shifts. This could lead to a need for the Federal Reserve to tighten monetary policy more aggressively than anticipated, potentially dampening the economic outlook in the short run.
Another factor contributing to the rise in bond yields is the increasing deficits and the reduction in demand for Treasuries from emerging market central banks. As central banks run down their balance sheets, the private sector is left to absorb the excess supply of bonds. This has caused the term premium embedded in long-term bond yields to rise, even if the Fed has finished tightening policy rates. Liquidity specialists warn that this could lead to a ‘duration crisis’ and have significant ramifications for the credit system. If the value of ‘safe assets’ falls, their use as collateral in credit and liquidity creation could be damaging.
Overall, the recent surge in long-term borrowing rates has unnerved financial markets. While there are positive indicators, such as strong economic performance and the potential for rising trend growth, there are also concerns about rising debt levels and structural shifts. The increase in deficits and the reduction in demand for Treasuries from emerging market central banks could further push up bond yields. As the situation unfolds, investors will be closely watching the impact on corporate earnings, investment, and the overall stability of the credit system.
Takeaways:
- The recent surge in U.S. long-term borrowing rates has unsettled financial markets.
- Strong economic data and the potential for rising trend growth are positive indicators.
- Rising debt levels and structural shifts may be contributing to higher interest rates.
- Increasing deficits and reduced demand for Treasuries from emerging market central banks are driving up bond yields.
- The rise in bond yields could have both positive and negative implications for corporate earnings, investment, and the stability of the credit system.
