The end of zero interest rates

WHAT a difference two years make. In 2021, when interest rates were near zero in the United States and the United Kingdom, and slightly negative in the eurozone and Japan, the consensus was that they would remain low indefinitely. Astonishingly, as recently as January 2022, investors put the probability of rates in the US, eurozone and the UK rising above 4 per cent within five years at only 12 per cent, 4 per cent and 7 per cent, respectively. After adjusting for expected inflation, real interest rates were negative and projected to stay that way.

In fact, despite the US Federal Reserve and other central banks’ aggressive monetary tightening, real interest rates remained significantly negative until late 2022. Moreover, long-term rates increased more moderately than short-term rates: by October 2022, the yield curve had inverted, signalling that financial markets were expecting central banks to reduce short-term rates in the near future. This sentiment stemmed from the widespread expectation that both the US and global economies would enter recession.

The Fed recently raised its policy rate to 5.25 per cent. In the US and many other countries, real interest rates have also moved into positive territory. And now that the US appears to have avoided a recession after all, rates will likely stay well above zero for a while.