Are High-Interest Rates the New Norm?

This week, the FED and the Bank of England kept interest rates at 5.25% - 5.50% for the second time in a row. This level is a 22-year high, but is this something that we can expect for the immediate future?

In Q3, we saw reports of US Real GDP Growth rising to 4.9% due to increased consumer spending. However, we also witnessed uncertainty and volatility in the Equities market, with the S&P 500 and FTSE100 affected by geopolitical tensions between Israel and Palestine. Birkenstock’s IPO fell 13% on its first day of trading! Commodities rose higher, with the 'safe-haven' investment of Gold reaching levels above $2,000 and Oil rising to above $90 a barrel due to supply concerns if Middle Eastern countries got involved in the conflict. Bonds rallied throughout October, with the 10-Year US Treasuries Yields almost reaching 5% and 10-Year UK Gilts peaking at 4.7%. With all this rising tension and volatility in the market, there is no reason for Central Banks to lower rates anytime soon. The Bank of England stated: '[rates can be expected] to remain at 5.25% until August 2024, before the first of an expected four 25 basis point cuts.' Analysts expect interest rates to remain at this level until 2025, but what does this mean for consumers and businesses in general?

Consumers may have to accept interest rates at this level. High borrowing costs for loans and mortgages have become standard for many months now, and with no upcoming good news, we can still expect interest rates to remain at the same level or continue to rise throughout 2024. US consumers have remained resilient in the last few months, with spending and the robust job market seemingly unaffected by the aggressive FED decisions. Businesses looking to raise capital through debt will also have to accept high-interest rates. As we know, there is a relationship between interest rates and bonds. When interest rates rise, the yield on new issuance bonds rises, and the value of current bonds drops. This is due to the calculation of a bond's value being based on future cash flows being discounted at the current interest rate. Therefore, old bonds with lower yields being discounted at a higher interest rate than when they were issued suffer a drop in value.

Corporate bonds must apply a premium to their bonds to attract investors instead of targeting government-grade bonds, UST 10-year yields. We saw back in July that Morgan Stanley issued $6.75 billion in corporate bonds with around a 1.5% premium against UST 10-year yields, which was between 3.8% and 4% during that time. With UST 10-year yields currently at 4.8% at the time of writing, businesses may have to accept these high yields before it is too late and new issuance bonds rise above the 5% level. This is a concern for businesses as they may worry if they have enough cash flow to pay these debt obligations, with revenue and profit low due to lower retail consumption. However, businesses must endure, and accepting high-interest rates may be the only option for them to survive and stay intact. Bloomberg supports this as they reported: 'Companies are rushing to sell bonds before interest rates rise further, as the era of cheap money comes to an end. In October 2023, companies sold a record $81.75 billion in bonds, just shy of estimates of $85 billion. This is a sign that companies are eager to lock in lower borrowing costs before they go even higher.’

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