The United States is experiencing a secular change towards higher average interest rates after almost fifteen years of historically low borrowing costs. The 10-year treasury rate has been continuously below 4% since 2008, which is an anomaly compared to the previous 54 years. Economic forces are driving longer-dated interest rates higher, suggesting a prolonged period of elevated rates. Inflation has been fluctuating, but expectations of higher inflation rates are becoming entrenched, leading lenders to demand higher interest rates to protect against inflation.
The Federal Reserve is unlikely or unable to intervene in the rise of long-term interest rates, as buying bonds may further stimulate the economy and inflation. The economy needs to cool down, demand must decrease, and wage growth should stabilize or retreat to control inflation. The government’s massive deficit spending, which is over 6% of GDP annually and expected to rise to 7% in 2024, is acting as direct stimulus to the economy, leading to higher prices and offsetting monetary policy efforts to control inflation. Secular changes in interest rates happen slowly, and while the Federal Reserve may introduce surprises, significant reforms and stable inflation will be needed to moderate interest rates in the long term.
Investors should be aware of the increasing likelihood that the U.S. is entering an era of higher rates, which will impact investments and markets. If rates remain elevated, stock market momentum may slow or reverse, resulting in potentially negative real returns for investors in the coming years. Diversification and controlling leverage are key strategies to navigate the risks posed by the changing economic environment. Higher interest rates also present opportunities for investors, as bonds could become more attractive than they have been in decades.
Overall, the trend towards higher interest rates in the U.S. is driven by economic forces and inflation expectations, which are influencing longer-dated rates. The Federal Reserve may be limited in its ability to control long-term rates, given the current economic conditions and government deficit spending. Investors should be prepared for higher rates and their impact on investments, as well as consider strategies to mitigate risks and capitalize on potential opportunities presented by the changing interest rate environment.
