Zoom out: It is clearer than ever that the era of cheap borrowing and abundant capital that lasted from 2008 to 2021 is well and truly over.
- Every individual seeking to take out a mortgage or car loan competes with the voracious capital needs of AI giants and the US government.
- While the Federal Reserve has stopped predicting its next actions, it now appears out of position. Its leaders increasingly believe they have set policy rates too low to control inflation amid a growth boom, and are now seeking to adjust course, meaning last week’s rate hike won’t be the last.
- Rate hikes may not do much to discourage investment in AI or government borrowing, leaving all other interest-rate-sensitive sectors responsible for rebalancing the economy.
Zoom: The rate hike has been driven largely by a rise in real yields – implying stronger growth prospects, not a burst in expected inflation.
- Investors can now buy 30-year inflation-protected Treasury securities yielding 3.26 percent, the highest since 2002. This time, five years ago, that number was negative.
- The forward earnings yield for the S&P 500 is about 5%. With a nominal yield on 30-year Treasuries of around 5.5%, bonds look more attractive relative to stocks than they have in a long time.
State of affairs: The recent rise in long-term rates is poised to push 30-year fixed-rate mortgages closer to 8%. Mortgage News Daily on Thursday pegged the 30-year rate at 7.45%, or 7.55% for jumbo loans.
- Mortgage rates reached this level briefly in the fall of 2023, but the last time they exceeded this level sustainably was in 2000.
- Over time, the real estate market can find an equilibrium. But in the short term, rising rates are just a sign of pain as the market freezes.
- People can’t afford to buy homes with interest rates higher than 7.5%, and sellers don’t want to lower their prices. So there is stagnation, as we saw in the fall of 2023, until rates fall or prices adjust.
The plot: Higher rates, if sustained, will make the U.S. fiscal situation considerably thornier.
- The cost of servicing the U.S. government’s debt was already expected to reach new heights in the years to come – but that burden will be much worse if the rate hikes of recent weeks continue.
In figures: According to projections produced by the Congressional Budget Office last February, net interest costs are already at $1 trillion this year and on track to reach $2 trillion by 2035, meaning much of the federal spending is needed just to pay old bills.
- But those projections assumed 10-year Treasury yields were around 4.3%. They are now almost a percentage point higher than that figure.
- According to surprising figures released this week by the CBO, in a scenario in which interest rates are 1 percentage point higher than their baseline scenario, public debt would reach 222 percent of GDP in 2056, or 47 percentage points higher than the baseline scenario.
Reality check: Higher interest rates are not immediately reflected in public debt servicing costs. Longer-term bonds mature gradually over time.
- Thus, a reversal of rates would make budgetary calculations easier (at least as long as it is not caused by a recession or a drop in productivity).
The bottom line: If the world of 5% is here to stay, it requires a rethinking of U.S. government tax and spending policies, asset prices and, more generally, what we consider normal in an era of strong global demand for capital.
- And this adjustment is only just beginning.
Gn bussni
