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High interest rates are here to stay

Here comes the bear market. Credit: Getty

August 18, 2023 - 1:15pm

US mortgage rates hit a two-decade high yesterday. Take it as a sign of things to come. Not only will interest rates probably rise a bit more, but they may not then come down by much. In fact, we may be looking at the new normal.

Investors carrying lots of debt are holding on for dear life. For decades, whenever things went south in asset markets, central banks rushed to the rescue. With inflation starting to moderate and economies slowing, expectations are thus growing in markets that we are nearing the peak of this tightening cycle, and that better days lie ahead. But this narrow focus on monetary policies overlooks something over which central banks have only limited control — the seismic change underway in global bond markets.

After the advent of the neoliberal regime and its ultra-tight monetary policies in the early 1980s, Western bond markets entered what would be a decades-long bull market. With workers bearing the brunt of disinflation as real wages stagnated, government deficits and inflation fell, making debt an attractive investment. Prices on Western government bonds rose with demand and so, given the way bond markets work, their yield — effectively, their interest rate — fell. Demand was further driven higher by Japan’s prolonged slump and China’s export-led boom, which created huge demand in Asian markets. Moreover, given their relatively good fiscal health, Western governments then enjoyed a premium, seeing as loans to them were considered very secure.

Recently, though, all of that has gone into reverse. Inflation has risen in Western countries, and may well settle into a higher range than in the past. Meanwhile, Japan appears to have finally emerged from its slump, and its central bank is tightening policy in response, reducing that country’s appetite for US treasury paper. So too China, whose slowing exports are reducing its dollar surpluses. Meanwhile the need for fiscal stimulus may lead Beijing to draw down its reserves.

Finally, while Western government debt levels surged in the pandemic, that of many emerging markets has held more steady, and now stands at lower levels. So whereas Western governments were once the safe bets and emerging markets paid a risk premium, increasingly, developing countries are looking like the grown-ups in the fiscal room, making their bonds more attractive. Western governments are having to compete for credit — and as their populations age, the pressure to borrow more will intensify.

Add it all up and it’s looking increasingly like the decades-long bull market in Western government bonds has given way to what may be an equally long bear market. That will keep upward pressure on rates from here on in. So anyone who built up a lot of debt in the easy-money years, when it looked like interest rates would stay low forever, may soon face a reckoning.

In particular, investors who piled up loans to buy assets, in the days when credit was cheap and asset prices seemed only ever to rise, may be forced to liquidate holdings to cover their rising costs. That could trigger a surge in supply that drives down prices, leaving leveraged investors even worse off.

In consequence, the risk of crashes in some assets can’t be ruled out. British real estate may come under further pressure and American stock markets look shaky. There may be real pain in commercial real estate. Bitcoin may be the canary in the coalmine: if it heads south sharply, it may indicate a ‘risk-off’ rush in markets, which could signal trouble ahead for other assets. Reports that Elon Musk sold off his bitcoin holdings overnight can’t have helped that cause.

A 2008 crash may not be on the horizon, but anyone carrying a lot of debt may want to assess their position, because it’s looking ever more likely that these high interest rates are here to stay.


John Rapley is an author and academic who divides his time between London, Johannesburg and Ottawa. His books include Why Empires Fall: Rome, America and the Future of the West (with Peter Heather, Penguin, 2023) and Twilight of the Money Gods: Economics as a religion (Simon & Schuster, 2017).

jarapley

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Matt M
Matt M
9 months ago

I recently came across these stats and found them surprising and explanatory.
In England there were 24.9M dwellings in 2021 (latest figures). Here is the breakdown on ownership:
9.3 million (37%) were owned outright
6.5 million (26%) were owned with a mortgage or a loan
4.9 million (20%) were private-rented
4.2 million (17%) were in social rent, mainly rented from housing associations and Local Authorities
The number of “owned outright” dwellings is increasing by about 500k a year and is going to continue as the mortgage holders of the house buying boom of the 1990s/2000s pay off their loans in the next few years (me included hopefully). It is likely that in the next few years more than half the dwellings in England will be owned outright by their occupiers. This must be the first time that this has happened in the history of England.
Perhaps householders are less worried about rising interest rates than you would expect because the majority of them have either paid off their mortgages or are close to doing so and so have a small outstanding loan. If anything, they are likely to be savers who will benefit from higher rates.
It is going to be tough for people over-extended on the buy to let market though, and by extension on the 20% of households that rent privately. And it will decimate the commercial property sector already weakened by WFH.

Last edited 9 months ago by Matt M
Matt M
Matt M
9 months ago

I recently came across these stats and found them surprising and explanatory.
In England there were 24.9M dwellings in 2021 (latest figures). Here is the breakdown on ownership:
9.3 million (37%) were owned outright
6.5 million (26%) were owned with a mortgage or a loan
4.9 million (20%) were private-rented
4.2 million (17%) were in social rent, mainly rented from housing associations and Local Authorities
The number of “owned outright” dwellings is increasing by about 500k a year and is going to continue as the mortgage holders of the house buying boom of the 1990s/2000s pay off their loans in the next few years (me included hopefully). It is likely that in the next few years more than half the dwellings in England will be owned outright by their occupiers. This must be the first time that this has happened in the history of England.
Perhaps householders are less worried about rising interest rates than you would expect because the majority of them have either paid off their mortgages or are close to doing so and so have a small outstanding loan. If anything, they are likely to be savers who will benefit from higher rates.
It is going to be tough for people over-extended on the buy to let market though, and by extension on the 20% of households that rent privately. And it will decimate the commercial property sector already weakened by WFH.

Last edited 9 months ago by Matt M
Andrew Wise
Andrew Wise
9 months ago

Hardly a surprise given the rampant money printing that’s been going on since they invented Quantitive Easing and pretended it wasn’t money printing.

Andrew Wise
Andrew Wise
9 months ago

Hardly a surprise given the rampant money printing that’s been going on since they invented Quantitive Easing and pretended it wasn’t money printing.

j watson
j watson
9 months ago

Rates at some point were going to return to historical norms and that seems to be where things will settle. The rates are not historically high. The problem is the pace at which they rose which did not enable a gradual adjustment for those with business debt or things like mortgages. That means a v painful adjustment for some, the ripple effect of which may have much broader consequences.

Samir Iker
Samir Iker
9 months ago
Reply to  j watson

If rates go back to historical highs of the 80s and 90s, we are all f***ed

Peter B
Peter B
9 months ago
Reply to  j watson

I think the problem is as much interest only mortgages and the actual size of the loans. The media “experts” blather on about mortgage affordability without ever realising that a loan of 3X at 3% is a very different proposition than a loan of 1X at 9% – the first loan is more expensive over the full term since there’s a larger principal to repay. All these fools that think that excessive house price inflation is a good thing and can go on forever …
I don’t think rates have risen that quickly by historic standards. People have been duped into living in a fool’s paradise for over two decades.

Samir Iker
Samir Iker
9 months ago
Reply to  j watson

If rates go back to historical highs of the 80s and 90s, we are all f***ed

Peter B
Peter B
9 months ago
Reply to  j watson

I think the problem is as much interest only mortgages and the actual size of the loans. The media “experts” blather on about mortgage affordability without ever realising that a loan of 3X at 3% is a very different proposition than a loan of 1X at 9% – the first loan is more expensive over the full term since there’s a larger principal to repay. All these fools that think that excessive house price inflation is a good thing and can go on forever …
I don’t think rates have risen that quickly by historic standards. People have been duped into living in a fool’s paradise for over two decades.

j watson
j watson
9 months ago

Rates at some point were going to return to historical norms and that seems to be where things will settle. The rates are not historically high. The problem is the pace at which they rose which did not enable a gradual adjustment for those with business debt or things like mortgages. That means a v painful adjustment for some, the ripple effect of which may have much broader consequences.

Arkadian X
Arkadian X
9 months ago

I would have thought that interest rates at about 5% would be the norm.

Arkadian X
Arkadian X
9 months ago

I would have thought that interest rates at about 5% would be the norm.

Steve Jolly
Steve Jolly
9 months ago

The market has been floating on cheap Chinese labor, which enabled corporate cost cutting that held inflation down despite low interest rates. The twenty years of low interest low inflation corresponds perfectly with China’s rise as the world’s factory floor. Only now are our incompetent overlords realizing they’ve been had.

Steve Jolly
Steve Jolly
9 months ago

The market has been floating on cheap Chinese labor, which enabled corporate cost cutting that held inflation down despite low interest rates. The twenty years of low interest low inflation corresponds perfectly with China’s rise as the world’s factory floor. Only now are our incompetent overlords realizing they’ve been had.

Andrew R
Andrew R
9 months ago

Interest rates should have been slowly increasing from around 2003/4.Why weren’t they, I think we have pretty good reasonfor that…

Samir Iker
Samir Iker
9 months ago
Reply to  Andrew R

Yep, should have been in the 3-4% range at least, near zero for such an extended period was ridiculous.

Samir Iker
Samir Iker
9 months ago
Reply to  Andrew R

Yep, should have been in the 3-4% range at least, near zero for such an extended period was ridiculous.

Andrew R
Andrew R
9 months ago

Interest rates should have been slowly increasing from around 2003/4.Why weren’t they, I think we have pretty good reasonfor that…

Prashant Kotak
Prashant Kotak
9 months ago

“The West may be about to experience a decades-long bear market”

Ya think?

Prashant Kotak
Prashant Kotak
9 months ago

“The West may be about to experience a decades-long bear market”

Ya think?

Right-Wing Hippie
Right-Wing Hippie
9 months ago

I’m sure the magicians at the central banks will pull some rabbit or other out of their hats and save us all from the consequences…well, the consequences of somebody’s actions. Not mine, though. I’m completely blameless in this affair. Now give me my free money.

Right-Wing Hippie
Right-Wing Hippie
9 months ago

I’m sure the magicians at the central banks will pull some rabbit or other out of their hats and save us all from the consequences…well, the consequences of somebody’s actions. Not mine, though. I’m completely blameless in this affair. Now give me my free money.

David George
David George
9 months ago

Worth noting, for context, that we’ve just moved from the lowest interest rates in the 5,000 year history of money.
“Business as usual” it isn’t.

David George
David George
9 months ago

Worth noting, for context, that we’ve just moved from the lowest interest rates in the 5,000 year history of money.
“Business as usual” it isn’t.

Rob Cameron
Rob Cameron
9 months ago

This issue has been piling-up pressure since the late 1980s during the tenure of Alan Greenspan at the US Fed. His successors have continued the largesse includuding quantative easing and furlough schemes during Covid.
This easy-money policy has shielded the populous from short-term pain but has led to bigger long-term problems caused by spiralling debt mountains.
We’ve seen bubbles like dot-com stocks and the US mortgage nonsense that led to the Global Financial Crisis. Now, just have a look at the so-called ‘Magnificent 7’ US stocks. Apple Inc is allegedly worth more than the whole of the FTSE 100 on lower turnover and lower profit. If this isn’t a bubble, I don’t know what is. High interest rates and the US economy going into recession are going to illuminate the issues. The tide is going out and we will shortly see who’s not wearing their swimming costume.