Higher Interest Costs Will Continue for Some Time, Study Says

The so-called ‘natural interest rate’ is on the rise and will keep the cost of money aloft into the 2030s, per Bloomberg Economics.



You have heard the phrase “higher for longer” about interest costs. For how much longer, though? By one estimate, well into the next decade.

The common wisdom is that the Federal Reserve sets interest rates, and, indeed, the body’s federal funds rate is the key U.S. benchmark for other rates. But a broader force is at work, long known in economics as “the natural rate of interest,” also known as a neutral interest rate or R-star.

This “natural” rate is on the ascent and projected to remain high into the 2030s, according to research by the Bloomberg Economics unit. If that is accurate, overall interest charges, for everything from corporate bonds to credit card loans, will remain on the high side for some time, compared with the low cost of money people had enjoyed until last year.

Previously, the natural rate—which would keep the economy in balance at full employment (typically 95% or above)—was estimated in the vicinity of 1.7%, and now it is approaching about 2.7%, where the Bloomberg study predicted it will stay for years into the 2030s. This rate is a baseline, and longer-term bonds will yield at least a couple of percentage points above it.

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The Bloomberg economists noted that the natural rate is hard to place with precision because it is an agglomeration of numerous factors that range far beyond Fed actions. It is a theoretical estimate and depends on some factors that cannot be measured and others that move in opposite directions.

Current examples: rising inflation, higher levels of government borrowing, bigger climate change spending from private and public sources, retiring Baby Boomers drawing down their savings, and an explosion in technological advances, particularly artificial intelligence.

Different scholars have put these all together in different ways, but the Bloomberg estimates generally agreed with others in pointing toward higher-for-longer rates. The lack of more precise figures—such as the exact current rate—has spurred Fed Chair Jerome Powell to downplay the natural rate’s usefulness.

A Bloomberg summary (the study was not released by Bloomberg’s economics unit) explored the impact on the U.S. economy of a higher natural rate. For instance, Bloomberg indicated, the 10-year U.S. Treasury yield could settle around 4.5% to 5%, where it is now, or perhaps as high as 6%.

A long spell of higher rates would have both pluses and minuses, the Bloomberg study suggested. On the negative side, there will be many years ahead where more companies will be unprofitable due to higher borrowing costs, homeowners will have higher mortgage costs, the stock market will face headwinds as low rates vanish, and Washington will have a bigger interest payout, thus risking deeper deficits. On the positive side, bondholders will enjoy sweeter yields. Any impact on inflation, however, is not known.

 

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