Tides of Credit
Most Americans, and people across the planet, have been trained by a financial system where borrowing costs became perpetually cheaper. If you got into a pinch, you could refinance your mortgage, with more agreeable terms, and quickly increase your cash flow.
Finance
You could also pull out some equity and upgrade your kitchen, pay off your credit cards, take a vacation, or play in the stock market. What a delight.
If you took out a mortgage, expanded a business, or looked at a government balance sheet anytime between the Reagan administration and the dawn of the 2020s, the wind was firmly at your back. Biting off more than you could chew was often rewarded.
But credit cycles operate in massive, multi-decade tides. Their movements are broad and sweeping. And right now, after four decades, the tide is rushing out. The tranquil waters of easy liquidity have turned into a harsh and turbulent macroeconomic sea.
Perhaps you’ve noticed your credit card rates creeping up. Or you’ve looked into a car loan to finance a new vehicle purchase. If so, you’ve seen the painful reality of higher borrowing costs. At the same time, your bond portfolio’s taken a hit. Losses in what was supposed to be the safest corner of your nest egg were not supposed to happen.
We are witnessing a profound, structural change in the credit market. The decades-long era of ever cheaper borrowing costs is over. Now, the impacts of a new, higher-for-longer reality must be reckoned with. This shift will fundamentally redefine how we spend, save, and invest for a generation.
In short, the world has become less agreeable to borrowers. This has happened before. But unless you’re over 70, you have little experience with what it means.
Pendulum Swings
To understand where we are going, we have to look at where we’ve been. Interest rate cycles don’t move on a dime. They span many decades like a slow-moving macroeconomic pendulum.
To combat runaway stagflation in the early 1980s, Fed Chair Paul Volker jacked up the federal funds rate. This pushed the 10-Year U.S. Treasury rate to a lofty 15.32 percent in September 1981.
At that point, after consistently rising since December 1940, interest rates finally peaked out. Then, for nearly 40 years, with the help of globalization, technological deflation, cheap oil, and extreme central bank intervention, the 10-Year Treasury rate consistently declined. Finally, in July 2020, it bottomed out at an all-time low of 0.62 percent.
That was the absolute floor. Since that historic low, rates have steadily marched upward, recently hovering around 4.5 percent.
On paper, 4.5 percent doesn’t sound too bad. It’s roughly the historical mean for American borrowing costs. But before this cycle is over, it’s highly likely that rates will climb much higher. There may be cyclical declines within the larger secular trend. Nonetheless, we’re in the early days of a long-term upward trend. The structural forces that once suppressed yields have fundamentally inverted, creating a permanent tailwind for inflation and rising rates.
Economics
A recent Bloomberg survey of top economists underscores this shifting reality. The cohort now anticipates that the U.S.-Iran conflict will serve as a lasting catalyst, driving a permanent uptick in global borrowing costs. As a result, average benchmark interest rates across advanced economies are predicted to register at 2.9 percent by year-end 2028, a sharp upward revision from the 2.47 percent estimate economists held just at the start of the year.
You may look at oil prices and take comfort that they’ve abated. We believe this is the calm before the storm. That the oil shock triggered by the closure of the Strait of Hormuz is still manifesting. And that the strategic petroleum reserve (SPR) will not be able to provide a buffer for much longer – especially for diesel and jet fuel.
Regardless, the underlying inflation problem has mutated. It is no longer just about expensive oil. It has broadened into a sticky, systemic issue.
When core inflation refuses to cool down, central banks have their hands tied. They cannot aggressively cut rates without risking an absolute bonfire of consumer prices. Consequently, structurally higher inflation means structurally higher interest rates.
Borrower’s Burden
When the cost of capital rises, everyone pays the price. For the average consumer and business, this means a steady tightening of the economic screws.
The days of the 3 percent 30-year fixed rate mortgage are gone and will not return in our lifetimes – if ever. Auto loans, credit card APRs, and personal lines of credit are all resetting higher, chewing through discretionary income.
Companies reliant on rolling over short-term debt to fund operations or expansion are discovering that capital now comes with a premium. Margins are getting squeezed, forcing a harder look at hiring, capital expenditures, and growth targets.
But the most evident vulnerability isn’t on Main Street. It’s in Washington. The U.S. Treasury is the largest borrower on the planet. For decades, it ran up trillions of dollars in national debt while enjoying the luxury of lower and lower interest rates. Servicing that debt was incredibly cheap.
Now, a massive wall of that legacy debt is maturing and must be rolled over (reissued) at today’s significantly higher market rates. When the baseline rate climbs from 0.62 percent toward 4.5 percent and beyond, the servicing costs become brutal.
Every tick upward in the benchmark yield requires the U.S. government to allocate hundreds of billions of additional dollars strictly to paying interest to bondholders. This crowds out tangible federal spending on infrastructure, defense, and social programs, while forcing the Treasury to issue even more debt just to pay the interest on the old debt.
Credit& Lending
It’s a compounding feedback loop of runaway government debt, which leaves the dollar, the world’s reserve currency, in a fragile fiscal position.
For generations, U.S. Treasuries were viewed as the ultimate financial ballast. If the stock market crashed or a war broke out, you hid in Treasurys. They were the risk-free asset class designed to preserve wealth through periods of instability.
Not anymore. Higher structural inflation and rising yields have severely eroded the appeal of sovereign bonds.
Dumping Sovereign Bonds
Consider what just happened at AMP Ltd., a major Australian pension manager. They recently disclosed that they have eliminated sovereign bonds from the retirement portfolios of younger investors, while aggressively paring back positions in their other funds. As AMP Chief Investment Officer Anna Shelley remarked:
“We’re in a long-term, structurally difficult market for bonds, and we’re not convinced they will provide the diversification benefits.”
Shelley’s not alone. Steven Barrow, the head of G10 strategy at Standard Bank, echoed this warning in a recent note to clients. Barrow pointed out a harsh truth that traditional portfolio managers are struggling to accept. That bonds have fundamentally failed to act as a safe haven during recent market crises.
What’s more, longer-dated yields have largely continued to move higher even during windows where central banks attempted to ease policy following the post-Covid inflation conflagration. When long-term yields climb while central banks try to cut short-term rates, it means the bond market is taking the steering wheel away from policymakers.
Investors are demanding a higher premium to hold long-term government paper because they simply don’t trust that inflation is under control.
“As a result,” Barrow concluded, “we view longer-term structural shifts from government bonds to other assets as the right way to go.”
In other words, the rules of the game have changed. The 40-year tailwind of falling interest rates is gone. In its place is a secular increase in borrowing costs driven by geopolitical frictions, structural inflation trends, and a massive supply of government debt.
Relying on government bonds to automatically protect your stock risk is a dangerous assumption in an inflationary, rising-rate world. The days of easy, predictable market safety are officially over.
Bonds
[Editor’s note: Get a free copy of an important special report called, “Fission for Millions – The Ultimate Bet on the AI Energy Crisis,” when you join the Economic Prism mailing list today. If you want a special trial deal to check out MN Gordon’s Wealth Prism Letter, you can grab that here.]
Sincerely,
MN Gordon
for Economic Prism
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