Regime change and US Interest Rates
Twenty years of subdued inflation, low interest rates, a reduced cost of capital and financial leverage have given way to a new regime. This is at the heart of our US 2025 10-Year-end forecast of 4.5% with risk of 5%.
For many investors and firm managers, this era is unfamiliar. Consider what is now in play:
-The term premium along the Treasury curve is positive.
-Higher interest rates have pushed up the weighted average cost of capital, raising the cost of doing business.
-Sticky inflation has altered household consumption.
-A transformed global policy framework is pushing firms to relocate production back to more friendly and expensive locales.
Should investors judge that expansionary fiscal policy is unsustainable, then long-term rates could exceed 5% or higher. we expect rates to fall along the short end of the Treasury curve between two years and five years over the next year, consistent with Fed intentions, but rise along the long end between 10 and 30 years based on the strength of the economy.
Since the Trump reelection, investors have been pricing in higher long-term yields. Unfunded taxes cuts and higher spending lead to a rising term premium on all Treasury issuance and higher yields along the spectrum.
The combination of policies that restrict aggregate supply (tariffs and deportations) while simultaneously stimulating aggregate demand (tax cuts & spending increases) will require something to give. And one of those things will almost certainly be rising interest rates at the long end of the curve even as the Fed cuts its policy rate.