Han Dieperink: Interest rate hysteria
This column was originally written in Dutch. This is an English translation.
By Han Dieperink, writing in a personal capacity
Long-term interest rates are rising, and this is rekindling old fears. In the United States, the yield on 30-year government bonds has risen above 5 per cent, the highest level since 2001.
The picture is no different in Europe. The German ten-year yield stands at around 3.32 per cent, its highest level in 15 years, whilst France, with a ten-year yield of 4.17 per cent, is back at pre-credit crisis levels.
After US national debt reached the 40 trillion dollar mark, government debt is said to have suddenly become unsustainable, and foreign investors are said to have lost confidence in Western government bonds. Even the government in Washington appears nervous, with a buy-back programme designed to keep long-term interest rates down.
Back to the old normal
It is tempting to go along with this sentiment. Although greed is a stronger emotion than fear, nothing sells better than an impending crisis. Yet what we are actually seeing is a return to normality – moving away from the ‘new normal’ and back to the ‘old normal’. For two decades, interest rates were, in fact, kept artificially low.
In the wake of the credit crisis, the world was grappling with a surplus of savings, a lack of growth, persistent deflation, and central banks that were stifling the capital markets with asset-purchase programmes and zero interest rates. At the height of this, bonds worth many trillions were trading at negative yields, meaning investors were effectively paying to lend out their money.
A CIO at a major Dutch pension fund told me at the time, with a certain degree of pride, that his fund held more than 100 billion euros in government bonds with negative interest rates. This implies, then, that the future is more certain than the present. For a pension fund, that is a curious investment strategy, driven more by the career risks faced by directors and regulators than by the aim of ensuring financial security for pensioners. That was an abnormal period – a time when, for the first time in history, our children were set to be worse off than we have been.
High debt, low interest rates
Ironically, history shows that it is precisely countries with high levels of debt that have suspiciously low interest rates. Take Japan, for example, which holds the record. Whilst the US debt-to-GDP ratio has been rising for decades since the 1980s, real interest rates have actually fallen. Over long periods, debt and real interest rates tend to move in opposite directions rather than in tandem. The claim that high debt automatically leads to high interest rates does not hold up empirically.
Investors constantly confuse fiscal risk with the term premium. Fiscal risk relates to the probability of default. For a country that borrows in its own currency and has a central bank behind it that will act as a buyer of last resort if necessary, that probability is virtually nil in nominal terms.
The term premium is something quite different. It is the extra return that investors demand to compensate for uncertainty about future inflation and the costs of refinancing. That premium has indeed risen, but at around 1 per cent it is roughly at the level seen in the 2000s and well below that of the 1980s and 1990s. So there is no question of a panic premium; rather, it is a case of normalisation.
Now, interest rates tell us little unless you compare them with income growth. The US economy is growing at a nominal rate of roughly 6.5 per cent, whilst the ten-year interest rate stands at around 4.6 per cent. As long as interest rates remain below nominal growth, an economy is effectively growing out of its debt.
This reflation is the opposite of a debt crisis; it is a solution that was regularly employed in the last century, including in the Netherlands. Anyone who invested in Dutch government bonds after the Second World War had lost around two-thirds of their purchasing power by the early 1980s – and that is based on the total return, excluding costs. In America, the situation was not much different.
More than just an American crisis
It is easy to lump Europe together with the United States. Here, however, the fiscal story does have more substance, and in one specific place: France. A eurozone country cannot print its own currency, and that makes all the difference. France’s national debt has risen to well over 110 per cent of GDP, the political landscape is fragmented, the annual budget battle has become a war of attrition, and the presidential elections are due in May 2027.
The widening yield spread between French and German government bonds is therefore no coincidence, but a genuine risk premium. Germany, on the other hand, is seeing its interest rates rise not out of fear, but due to a combination of its own fiscal expansion, a record supply of loans and the return of inflation. Two instances of rising interest rates, but two entirely different causes.
The global nature of this situation debunks the idea of a purely American fiscal crisis. The sell-off is happening everywhere. This year, Japanese, British and German government bonds have fallen even more sharply than their US counterparts. A problem occurring everywhere at once is not a national budgetary problem, but a structural shift: the end of zero interest rates, the withdrawal of central banks as major buyers, and the return of inflation risk into the price of money.
The Japanese 30-year government bond now yields 4.1 per cent, whilst the Japanese economy is growing nominally by around 3 per cent and is likely to slow towards 1 per cent to 2 per cent in the long term. Such a yield is simply too high. US government bonds, too, appear cheaper rather than expensive following the recent rise, particularly if disinflation persists and the central bank meets its inflation target.
For euro-denominated investors, the assessment is more nuanced, with a central bank that may raise rates again this month and with France as the weakest link. But here too, a higher interest rate primarily means a higher expected return.
Interest rates returning to normal are not a threat but, in fact, a blessing. They restore the anchor point for any investment and finally make bonds a class of asset worth holding again. Hysteria is rarely a good guide. The fundamentals give little cause for concern.
