The most notable development lately has been the rapid increase in U.S. long-term interest rates. There are two key factors driving this trend, culminating in a critical takeaway for your preparations.
- Resilient U.S. Economic Growth: The American economy continues to grow faster than anticipated, expanding by over 2.5% in the past year. This raises doubts about the prevailing expectation that growth will soon decelerate due to the high Fed funds rate (the very short-term rate controlled by the Fed). We have held reservations on this point for some time: fiscal stimulus in the U.S. remains strong, liquidity provisions are still ample, and monetary conditions are broadly supportive. This last factor is crucial as it encompasses real interest rates, credit spreads, the dollar's exchange rate, and credit availability, which businesses and individuals deal with far more than the Fed funds rate. Additionally, the previously inverted yield curve allowed for cheaper borrowing than the Fed funds rate for a sustained period.
- Political Influence on Markets: Markets are increasingly factoring in the possibility of the presidency and Congress being held by Republicans. This would mean significant tax cuts, resulting in even larger budget deficits, alongside higher import tariffs that would drive inflation. If Democrats secure a full victory, the deficit is expected to rise as well—mainly due to increased spending that would outweigh planned tax hikes, though to a lesser extent than with a Republican win. Should the presidency and Congress remain split, current policies will persist, resulting in continued large deficits, potentially exceeding 10% during a recession compared to the current 7%.
This is critical because, with high debt-to-GDP ratios and sustained interest rates, the cost of servicing debt could crowd out investments necessary for future growth. The U.S.'s potential growth is now estimated at around 2%, potentially slipping to 1.8% soon. Given the near-full capacity utilization, growth above this rate would likely accelerate wage pressures and inflation. Growth currently remains around 2.5%, with the possibility of further fiscal stimulus post-election. To prevent serious disruptions, a substantial increase in productivity is essential. Artificial Intelligence brings hope in this area, though most experts believe it will not significantly boost economy-wide productivity in the near term.
Yet, it would be an oversimplification to focus solely on the deficit’s size. Equally important is where the spending goes: consumption versus investment. Current policies involve substantial investment in technology and productivity-enhancing areas. Modern technology, in particular, is crucial to securing geopolitical and economic positioning. While Europe is lagging in this respect, with little chance of rapid improvement, China is not. This translates to rising import tariffs and escalating geopolitical tensions. It increasingly appears that financial markets are entering a new era. Until recently, there was widespread fear of deflation, prompting massive fiscal and monetary stimulus in a relatively stable geopolitical environment. This is now shifting:
- The U.S. faces challenges from its ballooning public finances. Where will this lead? Higher taxes, major spending cuts, or both? And how might this affect the development of modern technology?
- China struggles with a "Balance Sheet Recession." Western experience shows how extremely difficult it is to recover from this.
- Europe is caught between China and the U.S. and seems unable, for now, to become a significant economic or military power.
- The era of deflationary fears and vast money creation is over.
Our conclusion: We should prepare for much greater volatility ahead.