Financial markets indicate that interest rates will remain high for years to come, so borrowers hoping for relief from higher rates may be disappointed.

Money market pricing, regardless of how much they decline in 2024, underscores the belief that, as long as inflationary pressures and government expenditure remain elevated, the decade of nearly zero interest rates that followed the Great Financial Crisis is unlikely to repeat.

For many public and private borrowers who locked in lower rates in the past and haven’t yet seen the full effect of the record-paced central bank hikes of the previous two years, that could mean further suffering.

Due to declining inflation and a dovish stance from the US Federal Reserve, traders have increased their wagers in recent weeks on anticipation of significant rate reduction for the following year.

Bond and equity markets have gained momentum due to expectations that interest rates in the US and Europe will decrease by at least 1.5 percentage points.

However, money market pricing indicates that although the Fed is anticipated to lower its main rate to around 3.75% by the end of 2024, it would only do so to about 3% by the end of 2026 before rising to roughly 3.5% once more.

Comparatively speaking, rates remained close to zero for the majority of the ten years that followed the global financial crisis, until progressively increasing to 2.25%–2.50% in 2018.

Rates at the European Central Bank are expected to drop from 4% to about 2% by the end of 2026; this is a decrease, but it hardly indicates a return to the unconventional experiment with negative rates that was observed from 2014 to 2022.

“It’s just normalizing policy. It’s not going into easy monetary policy,” Mike Riddell, senior portfolio manager at Allianz Global Investors, said.

According to economists, such predictions are compatible with a scenario in which the so-called “neutral” interest rate—which neither accelerates nor decelerates economic growth—has increased since prior to the COVID-19 epidemic.

That argument has also been supported by the fact that the U.S. economy has managed to avoid the recession that many had predicted despite strong policy tightening.

The neutral rate, often known as the “R-star,” may be rising due to a number of variables, including looser fiscal policy, higher inflation risks brought on by geopolitical tensions and reshoring, and possible productivity gains from technologies like artificial intelligence.

Although it is impossible to calculate in real time, a concept of the neutral rate is essential to comprehending the potential for economic growth and to help central banks decide how much to lower interest rates in the future.

There is much disagreement over whether the neutral rate has increased and has changed.

Importantly, although some policymakers have placed it above 3%, market expectations for long-term interest rates are higher than the Fed’s 2.5% forecast.

ECB policymakers suggest a neutral rate of between 1.5% and 2% for the euro area.

“I’m sceptical that there’s been much of a change in R- star,” former Fed economist Idanna Appio, now portfolio manager at First Eagle Investment Management, said.

Appio is perplexed as to why markets are pricing in higher rates even though numerous indicators of inflation expectations indicate that rates should drop down towards the objectives set by central banks. She continued, “It’s too early to declare a rise in productivity.”

It is extremely difficult to predict where rates will go in the upcoming years, and markets can make mistakes.

For borrowers, however, who are still enjoying the low rates of the past few years and are accustomed to them, their expectations call for prudence.

“It means that corporates will need to refinance at reasonably to sometimes significantly higher rates than what they had in the books over the last five years,” Patrick Saner, head of macro strategy at Swiss Re, said.

“In this context, the higher rates environment actually matters quite a lot, particularly when it comes to corporate planning.”

(Adapted from Reuters.com)