Our Head of Corporate Credit Research explains why the legal
confusion over U.S. tariffs plus the pending U.S. budget bill
equals a revived focus on interest rates for investors.
Read more insights from Morgan Stanley.
----- Transcript -----
Andrew Sheets: Welcome to Thoughts on the
Market. I'm Andrew Sheets, Head of Corporate Credit Research at
Morgan Stanley.
Today I'm going to revisit a theme that was topical in January
and has become so again. How much of a problem are higher
interest rates?
It's Friday, May 30th at 2pm in London.
If it wasn't so serious, it might be a little funny. This year,
markets fell quickly as the U.S. imposed tariffs. And then
markets rose quickly as many of those same tariffs were paused or
reversed. So, what's next?
Many tariffs are technically just paused and so are scheduled to
resume; and overall tariff rates, even after recent reductions
towards China, are still historically high. The economic data
that would really reflect the impact of recent events, well, it
simply hasn't been reported yet. In short, there is still
significant uncertainty around the near-term path for U.S.
growth. But for all of our tariff weary listeners, let's pretend
for a moment that tariffs are now on the back burner. And if
that's the case, interest rates are coming back into focus.
First, lower tariffs could mean stronger growth and thus higher
interest rates, all else equal. But also importantly, current
budget proposals in the U.S. Congress significantly increase
government borrowing, which could also raise interest rates. If
current proposals were to become permanent. for example, they
could add an additional [$]15 trillion to the national debt over
the next 30 years, over and above what was expected to happen per
analysis from Yale University.
Recall that prior to tariffs dominating the market conversation,
it was this issue of interest rates and government borrowing that
had the market's attention in January. And then, as today, it's
this 30-year perspective that is under the most scrutiny. U.S.
30-year government bond yields briefly touched 5 percent on
January 14th and returned there quite recently.
This represents some of the highest yields for long-term U.S.
borrowing seen in the last two decades. Those higher yields
represent higher costs that must ultimately be borne by the U.S.
government, but they also represent a yardstick against which all
other investments are measured. If you can earn 5 percent per
year long term in a safe U.S. government bond, how does that
impact the return you require to invest in something riskier over
that long run – from equities to an office building.
I think some numbers here are also quite useful. Investing
$10,000 today at 5 percent would leave you with about $43,000 in
30 years. And so that is the hurdle rate against which all
long-term investments or now being measured.
Of course, many other factors can impact the performance of those
other assets. U.S. stocks, in fairness, have returned well over 5
percent over a long period of time. But one winner in our view
will be intermediate and longer-term investment grade bonds. With
high yields on these instruments, we think there will be healthy
demand. At the same time, those same high yields representing
higher costs for companies to borrow over the long term may mean
we see less supply.
Thank you as always, for your time. If you find Thoughts on the
Market useful, let us know by leaving a review wherever you
listen. And tell a friend or colleague about us today.
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