It's a 5% world. We're just living in it
Add Axios as your preferred source to
see more of our stories on Google.
Illustration: Brendan Lynch/Axios
The cost of borrowing money is moving unrelentingly higher, with profound implications for savers, borrowers and the U.S. government's fiscal outlook.
The big picture: The bond market moves over the last few weeks have pushed most risk-free interest rates north of 5%.
- Barring a rapid reversal, expect pain to come in interest-sensitive sectors like housing, new stress on federal government finances and greater risks of financial disruption.
- It is better news for savers, who have taken paper losses on existing bonds in recent weeks but can now deploy cash safely with the best prospective returns seen in decades.
Zoom out: It is clearer than ever that the era of cheap borrowing and abundant capital that lasted from 2008 to 2021 is well and truly over.
- Every individual looking to take a home mortgage or car loan is in competition with the voracious capital needs of the AI giants and the U.S. government.
- While the Federal Reserve has gotten out of the business of forecasting its next moves, it is now looking out of position. Its leaders increasingly believe that it has set its policy rates too low to control inflation amid a growth boom, and are now looking to adjust course, which means last week's rate hike won't be the last.
- Rate hikes may not deter much AI investment or government borrowing, which leaves all other interest-sensitive sectors to bear the brunt of bringing the economy into better balance.
Zoom in: The surge in rates has been driven for the most part by a rise in real yields — implying a stronger growth outlook, not an outburst in expected inflation.
- Investors can now buy a 30-year inflation-protected Treasury security that pays 3.26%, the highest since 2002. This time five years ago, that number was negative.
- The forward earnings yield of the S&P 500 is about 5%. With the 30-year nominal Treasury bond yielding around 5.5%, bonds look more attractive relative to stocks than they have in ages.
State of play: The recent surge in longer-term rates is poised to push 30-year fixed-rate mortgages to near 8%. Mortgage News Daily on Thursday clocked the 30-year rate at 7.45%, or 7.55% for jumbo loans.
- Mortgage rates got that high briefly in the fall of 2023, but the last time they were above that level on a sustained basis was in 2000.
- Over time, the housing market can find a balance. But in the near term, surges in rates just mean pain as the market freezes up.
- People can't afford to buy houses with 7.5%+ rates, and sellers don't want to cut their prices, so there is a standstill, as witnessed in the fall of 2023, until either rates fall or prices adjust.
The intrigue: Higher rates, if sustained, will make America's fiscal situation considerably thornier.
- The U.S. government's debt service costs were already projected to reach new highs in the coming years — but that burden will be much worse if the rate surge of the last few weeks is sustained.
By the numbers: In projections that the Congressional Budget Office produced last February, net interest costs are already at $1 trillion this year and on track to reach $2 trillion by 2035, meaning that much of federal spending is needed just to service old bills.
- But those projections assumed 10-year Treasury yields were in the ballpark of 4.3%. They're now nearly a full percentage point higher than that.
- In startling numbers that CBO released this week, in a scenario in which interest rates were 1 percentage point higher than its baseline, debt held by the public would grow to 222% of GDP in 2056, 47 percentage points higher than the baseline.
Reality check: Higher interest rates don't flow through to government debt service costs immediately. Longer-term bonds gradually mature over time.
- So a reversal in rates would help the fiscal arithmetic (at least so long as it wasn't caused by a recession or productivity slump).
The bottom line: If the 5% world is here to stay, it commands a rethinking of the U.S. government's tax and spending policies, the price of assets, and more generally what we consider normal in an era of steep global demand for capital.
- And that adjustment is in its early days.
