Interest rates

Higher interest rates likely to be factored into fiscal policy making

ANALYSIS – Long-term interest rates on public debt have skyrocketed since the start of the new year, a phenomenon that typically occurs when investors expect robust economic growth, higher inflation, or both. And some market analysts say there is room for rates to rise – which is never a good sign for US debt forecasts and the budget hawks’ appetite for more deficit spending.

The benchmark 10-year US Treasury yield, which influences lending rates across the economy, nearly hit 1.75% this week after Federal Reserve minutes showed central bankers could put end their unprecedented monetary policy stimulus faster than expected. Yields have not been this high since last March and are up from about 1.5% a week ago, an indicator that federal borrowing costs are on the rise.

Despite a COVID-19 variant causing more than half a million new cases per day and even closing some schools again, omicron is considered less serious than previous iterations of the virus and market players are looking beyond of the recent wave for continued economic recovery. Recognizing that inflation is no longer “transient”, the Fed is reacting with actions to try to calm the price hikes that have hit consumers’ wallets over the past year.

While inflation is expected to ease somewhat from recent highs, investor expectations for the average rise in the Consumer Price Index over the next five years hover around 2.8%, down compared to mid-November, but higher than before Christmas amid Omicron fears. Inflation and higher interest rates generally go hand in hand when investors sell fixed income securities in search of higher yields; when bond prices fall, yields rise.

And there’s another phenomenon at work: Jim Caron, chief fixed income strategist at Morgan Stanley, says investors anticipate a huge increase in the supply of Treasury debt in the year to come after she was temporarily depressed in part by massive Fed intervention. The Fed’s “quantitative easing” program, in which the central bank collected huge volumes of longer-term Treasury debt to pump money into the economy, helping to keep rates low and to stimulate borrowing, is coming to an end.