Higher Interest Rates Coming: A Decades-Long Cycle Ahead?
Summary
Interest rates are often seen as directly related to inflation, but there’s a crucial aspect of interest rate cycles that has been overlooked: risk. As we’ll explore in this comprehensive analysis, near-zero interest rates have become an anomaly that only occurred in the relatively brief period of 2011-2022. In contrast, for five decades between 1960 and 2007, interest rates over 4% were the norm.
The Forgotten Years: Near-Zero Interest Rates as Anomalies
Interest rates are not just linked to inflation; they’re also tied to risk. This is often overshadowed by recency bias – the tendency to assume that recent trends will continue into the future. As a result, many believe near-zero interest rates are normal. They aren’t. According to historical data, such low rates were an anomaly limited to the period of 2011-2022.
The chart for 10-year US Treasury yields serves as a proxy for interest rates throughout the economy and illustrates this point well. Rates under 3% were not just an aberration but a brief anomaly that only occurred during a specific timeframe. In contrast, interest rates above 4% were the norm from 1960 to 2007. This includes glorious years like the 1960s, 1980s, and up until 1994, which featured stable growth and rising stock valuations.
Interestingly, for nearly 20 of the previous 25 years between 1970 and 1994, rates between 5.75% and 8% were normal. This data contradicts current misconceptions that near-zero interest rates are the norm. Rates have been rising steadily since the end of the financial crisis in 2009, but even they are significantly lower than their pre-2020 levels.
Decades Not Years: Understanding Interest Rate Cycles
It’s well-documented that interest rate cycles span decades rather than brief periods like the near-zero interest rates of the past decade. After rising for around a quarter of a century from 1955 to nearly 1981, rates declined sharply and remained low between then and into the early 2020s.
This 40-year period is an abnormality due in part to the influence central bank monetary policies had on interest rates during this period. Their efforts maintained unnaturally low rates for growth and stability. History suggests that once started, interest rates will continue to rise for nearly two decades before potentially peaking at historically normal levels of between 4% and 8%.
The Aftermath: A Higher Rate Environment
History indeed indicates that Treasury yields are likely returning to the historically "normal" range. When this happens, it increases the federal government’s burden of paying higher interest on its debt, effectively making those payments double in just a brief period.
The predictable outcome of maintaining near-zero rates has been an explosion of borrowing and spending fueled by nearly free money, which, as discussed, created unsustainable economic pressures that will lead to significant challenges when interest rates increase. The sharp rise in households’ interest payments due to increased debt is also part of this problem, not just because they’re paying more for the loans themselves but because their incomes are stagnant or decreasing.
Households face severe difficulties servicing these debts as wage earners continue to experience a long-standing free-fall in terms of income share. This leaves them with less disposable income for other expenses and limits the ability to take on even further debt, a sure pathway to recession.
The Intersection of Interest Rates, Inflation, and Risk
The cost of money is more closely tied to speculative excesses that generate credit-asset bubbles than simply inflation expectations alone. When these bubbles burst, they cause widespread destruction, destroying the artificial wealth created during their rise.
When lending is restricted due to high debt risk, it tends not to favor households or small businesses with modest collateral backing, significantly limiting access to affordable capital in a timely manner.
