As investors adapt to the notion of “higher-for-longer” interest rates, this phenomenon has ushered in a potential era of “lower-for-longer” growth. That shift occurred as recession predictions waned, driven by a 100bps surge in 10-year Treasury yields since mid-July, which breached, and continues to hover, around 5%.
Long-term Treasury yields surged, outpacing growth in short-term rates recently, dis-inverting the yield curve. That shift will likely hinder homebuyers, consumers and businesses, slowing economic activity. Identifying the causes of the bond market selloff is key to anticipating its impact.
While examining TIPS rates, it’s evident that inflation expectations haven’t surged. Five-year inflation expectations remained steady at about 2.2%. Additionally, the recent increase in real interest rates doesn’t align with stronger growth expectations, and it seems not to anticipate further monetary tightening by central banks.
That said, such driving forces behind recent market developments are worth exploring. In this article, I’ll dive into three of the top reasons why Americans should expect lower for longer interest rates and how it can happen as soon as 2024.
What Is Lower for Longer?
Lower for longer refers to a scenario in which central banks, like the U.S. Federal Reserve, maintain low-interest rates for an extended period. The policy is often used to stimulate economic growth, encourage borrowing and investment and keep financial markets stable during times of economic uncertainty or crisis.
Why Lower for Longer?
Global central banks engaged in a vigorous campaign to combat inflation over the last two years, raising interest rates substantially. Advanced economies saw an average increase of about 400 basis points since late 2021 while emerging markets witnessed approximately 650 basis points of growth. While most economies adjusted to this assertive tightening, enduring core inflation in areas such as the United States and parts of Europe may require major central banks to maintain higher interest rates for an extended period.
That said, a lower for longer strategy can be expected anytime soon due to the following reasons.
Employment Statistics Weakens
In October, the U.S. Bureau of Labor Statistics announced an increase of 150,000 jobs, and the unemployment rate remained steady. Job growth was observed in healthcare, government and social assistance sectors, while manufacturing employment declined due to strikes.
The unemployment rate and the number of unemployed individuals barely changed in October, holding at 3.9% and 6.5 million, respectively. However, these figures have increased slightly since reaching their lowest points in April, rising by 0.5 percentage point and 849,000, respectively.
One aspect of the Fed’s dual mandate is ensuring price stability. That means maintaining low and steady inflation in the long term. Price stability ensures the value of money remains intact without concerns of it losing purchasing power due to high inflation. The Fed aims for an average inflation rate of 2% over time, as it allows the economy to operate efficiently and provides confidence to consumers and businesses in their financial plans.
The other aspect of the Fed’s dual mandate is achieving maximum employment. That means sustaining the highest level of employment the economy can support over time. To measure this, the Fed assesses various employment indicators, accounting for changing factors like business conditions, demographics and labor market regulations. The Fed doesn’t set a specific numerical employment target but relies on a diverse set of economic data to shape policies that promote maximum employment.
Financial markets aligned with this view. Bond yields dropped, and chances of a January rate hike decreased to 10% from 30% after the employment report release. Rate futures now imply a higher likelihood of a Fed rate cut by May 2024, with more cuts expected next year. Policymakers, including Fed Chair Jerome Powell, haven’t considered rate cuts. They are waiting for more evidence of economic balance after pandemic disruptions caused high inflation in 2022. However, Powell mentioned a possible rate hike, as they are not yet certain that monetary policy is sufficiently restrictive to reach the Fed’s 2% inflation target. He cited higher long-term borrowing costs, such as a near 8% increase in 30-year fixed-rate mortgages.
Rising Government Borrowing Costs
The connection between lower for longer interest rates and rising U.S. government borrowing costs can be complex, but it’s important to understand how interest rates and government borrowing costs are interrelated.
Borrowing costs are the interest rates the U.S. government has to pay when it borrows money through the issuance of bonds and Treasury securities to finance its operations, cover budget deficits and manage its debt. When the government borrows, it does so by issuing these debt securities, and the interest rates it offers on these securities determine the government’s borrowing costs.
So what’s the connection between the two?
In a lower for longer interest rate environment, the U.S. Federal Reserve and other central banks keep short-term interest rates (e.g., the federal funds rate) at historically low levels. That influences the overall level of interest rates in the economy, including longer-term interest rates, such as those on government bonds.
Additionally, the yields on government bonds are closely tied to prevailing interest rates. When central banks keep interest rates low, it puts downward pressure on bond yields. As a result, the U.S. government can issue new debt at lower interest rates, which helps keep government borrowing costs in check. It’s cheaper for the government to service its debt when it can borrow at lower interest rates.
On the other hand, when interest rates start to rise, either due to changes in central bank policies or market forces, the yields on government bonds also tend to rise. That means the government will have to issue new debt at higher interest rates, increasing its borrowing costs. Additionally, existing government debt with fixed interest rates becomes less attractive compared to newer bonds with higher yields, potentially causing the value of existing debt to decrease in the secondary market.
Low-Interest Rates Are Essential in the Economy
Certain parts of the economy, such as the housing market, are highly sensitive to interest rates. Low interest rates are typically associated with lower borrowing costs, which can significantly impact these sectors. For example, in the housing market, low interest rates can make mortgages more affordable, encouraging people to buy homes and invest in real estate.
Additionally, certain markets freezing up implies that, in some sectors or financial markets, economic activity has slowed down or even come to a standstill. That can be due to various factors, including economic uncertainty, reduced consumer or business spending or restricted access to credit. When markets “freeze up,” it can have negative consequences for businesses, jobs and economic growth.
To prevent a complete economic shutdown in certain sectors and to encourage economic activity, the Fed may consider cutting interest rates. When the Fed cuts interest rates, it typically aims to make borrowing more affordable, which can stimulate borrowing, spending, and investment in sectors that rely on low interest rates. That can help revive economic activity and address the issues of frozen markets.
Final Thoughts
In conclusion, the prospect of “lower-for-longer” interest rates in 2024 carries significant implications for individuals, businesses and financial markets. The three key reasons we’ve explored — economic recovery challenges, continued central bank support, and inflation dynamics — all suggest that low-interest rate policies are likely to persist.
As we move into 2024 and beyond, it’s essential to keep a watchful eye on the economic landscape and the decisions made by central banks around the world. These decisions will not only influence borrowing costs and investment opportunities but also have a profound impact on savings, retirement planning and the broader financial environment.
On the date of publication, Chris MacDonald did not hold (either directly or indirectly) any positions in the securities mentioned in this article. The opinions expressed in this article are those of the writer, subject to the InvestorPlace.com Publishing Guidelines.
