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Higher For Longer ? Maybe Higher Forever
It ’ s not all bad if borrowing costs stay higher .
By Allison Schrager
OUR HOLIDAY FROM HISTORY HAS come to an end . I am referring not to world peace but to the zero-interestrate environment so many people expected would last forever . Despite all the talk about when the U . S . Federal Reserve will cut rates and bring back those holiday vibes , there is a very real possibility that it will not matter when the cuts happen or how many there are .
That ’ s because the interest rates that matter for much of the economy — longer term U . S . Treasury bills — may not just be higher for longer : They may be higher forever . And that would mean a new era not only for investing but also for the economy .
While the Fed exerts control over short-term Treasurys , the research is mixed on how much influence it has on longer-term bonds . And the 10-year is what matters for how capital is priced and what rates consumers face . Its price tends to be driven by macro factors : the growth and inflation outlook of the economy , global and domestic demand for safe U . S . assets and , usually , the long-term debt of the federal government .
But on our holiday from history , the bond market appeared to have entered a new era . No matter the economic environment , yields went down and so prices went up : It was one long bull market . To some extent , this was justified by a low-inflation environment , an insatiable demand for U . S . debt from foreign governments , and various regulations that prized U . S . bonds as the world ’ s safe asset .
But bonds aren ’ t like stocks . Rates can fall only so low — no one will buy a bond that offers a negative 8 % yield . In the 2010s , real rates hovered around 0 %, in spite of the government piling on debt and a waning appetite for U . S . debt from its more reliable buyers . But that may have been an anomaly . Research on the 10-year yield going back to 1300 shows how it trended down as the world got safer and financial markets deepened . At the same time , the bond market has always had periods of highs and lows , and rates tend toward the mean .
The last 10 years was one of those low periods . Today , macro forces will probably push rates back up to 4 % or more : A higher and more volatile inflation environment is back , the government must issue more debt to pay for an aging population and ambitious industrial policy , and “ deglobalization ” will weaken demand for U . S . assets .
In short , there will be more debt , and it will be riskier . That means there will be less demand . Even if rates fall in the short term , there is a good chance they will settle at a higher level .
40 | FINANCIAL ADVISOR MAGAZINE | JUNE 2024 WWW . FA-MAG . COM