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