The interest rate of long-term safe assets (real and nominal) is perhaps the most important price in a capitalist economy. It tells a confidence about the government and the economy. These prices have normalized in recent years. Starting from 2007-09, the era of ultra-low interest rates seems to have ended due to the financial crisis. A normal era seems to be coming back. cheer! But the world doesn't look very "normal". Should we wait for a major impact?
Since the 1980s, the British government has been issuing index-connected gilding. Their output history provides us with three big stories of real interest rates evolving over three decades. The first is one of the huge secular declines. In the 1980s, the redemption rate for a 10-year term connected to the index was about 4%. During the pandemic and its immediate consequences, rates dropped to reduce 3%. The total swing is 7 percentage points. The second story is about how the economic downturn after the financial crisis led to very long sub-zero real interest rates. Starting from the beginning of 2022, the third rate of return has risen rapidly to about 1.5%. The long periods of decline in real interest rates ultimately resulted in the highest points of those negative real interest rates that seemed to have ended. We are in a new and not so strange world.
The earnings data for the 10-year term for the Treasury Inflation Protection Securities (TIP) give a similar situation, but this data has only been available since the early 2000s. Since 2013, the two series have diverged and are usually more productive on the US version. The difference may be partly due to the UK’s pension regulations, which are actually imposing cruel financial suppression on defined welfare pension schemes. Real interest rates on the tip also rose sharply from the troughs that arrived during the pandemic, but not as good as exponentially connected gold plating. As a result, these rates merged. Therefore, the nearest tip yield is about 2%, while the exponentially connected gold plating is close to 1.5%.
These levels are also close to where they were before the financial crisis. In these terms, we are "return to normal". But if we go back in time, we find that even today's UK index links have low yields: in the 1980s, interest rates were more than 2 percentage points higher than today.
No crisis is visible in these figures. The market in safe assets does not scream “the default is close.” For that matter, they also don't scream "over-inflation (even high inflation) is also nearby.
The simple way to observe the latter is to "break even" inflation rate, which is the gap between the index link of the same maturity and the yield of conventional debt. In the United States, the spread is about 2.3%, and the average has not been higher than 2.1% since January 2003. In the UK, it is 3.3%, which is only higher than the average of 3% after 2000. This gap has risen slightly due to the inflationary shock in recent years, so the inflation risk is more significant. The market seems very confident that inflation targets will take a hit within 10 years.
The story of other high-income countries producing returns in traditional bonds is consistent with the US and UK models and is mostly better. Between January 1, 2021 and May 28, 2025, the yield on the UK 10-year nominal bonds rose 4.5 percentage points, up 4.7%, in France, up 3.6 percentage points to 3.2%, in the United States, in Germany, up 3.6% to 4.5%, and in Germany, up 3.1% to 3.1%, up 3% to 3.6%, up 1.5% respectively. According to pre-2008 standards, these levels were moderate. Given this, a sharp reversal would seem unlikely without a large number of other negative shocks. At present, the ultra-low interest rate world at least 2008-21 seems to be over.
Is another big shock imaginable? Yes. Very chaotic decisions by the Trump administration may be shocked by animal spirits and investment. Indeed, it is surprising that consensus forecasts for U.S. growth in 2025 have dropped rapidly. Perhaps humiliation will tempt Donald Trump to refute what Robert Armstrong marked the tacos (Trump always trades chicken). Similarly, by historical standards, the overall level of debt is high, with the public sector debt-to-GDP ratio approaching 1945 levels. The United States is also starting financial deregulation while it is taking high leverage and financial risks. It also sustained a high fiscal deficit while trade and fiscal policies attacked its creditors.
Even after such a long ultra-low rate, the normalization of interest rates may prove too much. An obvious point here involves "equity risk premium". One way to measure this is to measure the gap between the cyclical adjustment of the yield rate of return on earnings (the reciprocal of the “periodicly adjusted price/income rate”) of U.S. stocks. The last gap (which indicates that long-term stock returns that expect exceed the stock exceed the tip) is as low as June 2007. It's hardly a comforting idea.
As Paul Krugman points out, the policy process in contemporary America, in particular, is trivial. At some point, important people may decide that the United States is no longer trustworthy. These people are likely to include Americans. Then, we may encounter a huge crisis, this time the capital flew out of the United States, rather than entering the United States.
Given all these vulnerabilities, recession or inflation shocks (even both) are conceivable. The yields of the most important financial instruments have been normalized. But the times are abnormal in many ways. Reality may prove that these prices are correct, or, als, it may blow them up. Either way, reality or these outputs have to be adjusted.
martin.wolf@ft.com
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