Foreign media pointed out that if the financial market's judgment is correct, interest rates in the US will not only remain high this year, but may even stay high forever.

The return of inflation means ultra-low interest rates are a thing of the past. Economists say that even after considering inflation, the neutral interest rate for a long-term balanced economy is rising, and this trend is currently reflected in the market.

Traders believe that by the end of this decade, US interest rates will stabilize at around 4%, far higher than policymakers' long-term expectations of 2.6%. Interest rates in the Eurozone, on the other hand, are expected to remain around 2.5%, which is higher than most of the EU's history.

Here are five key factors that determine long-term interest rates:

Government spending

Whether it's coping with climate change, huge investments in military demand, and rising interest costs, will keep the US government debt high. Economists dispute the impact of rising debt, but some expect spending demands to push up interest rates.

According to International Monetary Fund (IMF) estimates, developed economies' budget deficits account for 5.6% of output in 2023, almost double that of 3% in 2019, and will remain high at 3.6% until 2029.

Ed Hutchings, head of interest rates at Aviva Investors, said that a higher deficit would increase the premium required for investors to hold government bonds.

However, productivity growth is slowing, and potential growth rates in Europe and America are thought to be curtailed. Economists believe these factors will deter investment. “This will show that neutral policy interest rates will not increase much,” said Idanna Appio, a former Federal Reserve economist and portfolio manager at First Eagle Investment Management.

Higher consumer demand is seen as a key factor that will put upward pressure on interest rates

Ageing population

Dhar, a former Bank of England economist and Invesco Investments, said that the demographic structure is one of the biggest uncertainties affecting long-term interest rates.

Market consensus is that excess savings brought about by middle-aged and elderly people in wealthy countries accumulating savings before retirement depresses interest rates.

This situation is likely to continue, and the UN predicts that 16% of the global population will be over 65 by 2050, compared to 10% in 2022. Europe will particularly feel the impact of this change.

But the ratio of dependents (including retirees) to workers is rising. Economists Charles Goodhart and Manoj Pradhan believe this will reduce savings through age-related expenses, which in turn will push up interest rates. Nomura Securities said that using loans to fill the pension gap will also put pressure on interest rates.

climate warming

Assessing the impact of climate change on the economy is another major challenge.

The ECB's Isabel Schnabel said that the green transformation requires large-scale investment and may push up interest rates. The scale is comparable to what is needed to rebuild Europe after World War II.

The physical effects of climate change are also likely to trigger higher inflation and price fluctuations.

But according to an ECB paper, they could reduce global output by as much as 17% by 2050. This damage threatens productivity and could result in lower neutral interest rates.

The IMF said that more expensive clean energy may eventually reduce investment requirements, thereby lowering interest rates.

Soeren Radde, head of European economic research at hedge fund Point72, called the impact of climate change on interest rates a “major open debate.” “We are facing negative shocks that disrupt demand. It's unclear whether this will increase the neutral interest rate,” he said.

The boom in artificial intelligence

The extent to which the technological revolution can increase productivity and interest rates is a hotly debated topic.

Goldman Sachs predicts that AI-driven productivity increases may increase the US economic growth rate by 0.4 percentage points by 2034, and other developed economies by 0.3 percentage points. It anticipates upward pressure on interest rates, particularly if AI adoption is concentrated in the early stages.

Pioneer Group believes that if the impact of AI is comparable to electricity, growth will offset the pressure on the demographic structure. But if it's similar to computers and the internet, it might be disappointing.

A new reality

The COVID-19 pandemic, the Russian-Ukrainian conflict, the conflict between Palestine and Israel, and trade tension in the US all indicate rising supply chain risks in the future. Point 72's Radde said, “If the Federal Reserve has to respond... on average, this could also push up interest rates.”

Furthermore, the practice of “friend-shore outsourcing” — where Western countries and their companies seek to trade more with their allies — may also cause interest rates to rise. Roman Gaiser, head of fixed income at Columbia Threadneedle, said: “Essentially, any shift in production without considering the lowest cost will increase inflation.” Mexico, for example, is now America's largest source of imports.

Editor/Jeffrey