Mega trends could drive more elevated interest rates over the longer term

[SINGAPORE] Softer interest rates can be a boon for individuals and businesses. For one thing, US President Donald Trump has been pushing the Federal Reserve to lower interest rates more aggressively.

Whoever succeeds incumbent Jerome Powell, whose term as Federal Reserve chairman ends in May 2026, will likely be much more dovish on interest rates.

Cheaper debt helps indebted households as lower debt financing costs will mean higher disposal income. Meanwhile, businesses can invest more and/or enjoy higher profits when borrowing costs reduce.

Certainly, the decline in home loan rates has helped fuel private home buying activity here. The three-month compounded Singapore overnight rate average is well below what it was a year ago.

In the near term, interest rates could go lower, possibly to counter slowing economic growth. However, over a longer horizon of several years or more, might the risk be that interest rates are far higher than today?

Possibly, based on analysing various mega trends.

Rising sovereign debt

One, bond markets may increasingly baulk at rising debt levels in the US and other leading economies. 

In much of the developed world, there is enormous pressure on the fiscal purse to fund higher spending on defence, healthcare, pensions, welfare, infrastructure and so forth. However, as investors see credit metrics of countries weaken due to already highly indebted governments borrowing more, markets may demand much higher interest rates for sovereign debt including that of the US.

As it stands, many developed countries are struggling to get their fiscal houses in order due to political instability or lack of political will.

Indeed, the US’ ability to continue freely issuing treasury securities might face resistance as foreign governments seek greater diversification from US treasury securities.

Moreover, while the US dollar may be irreplaceable, confidence in the currency could ebb and efforts to find or develop alternatives to king dollar may gain momentum amid the US’ turning away from embracing global trade.

Deglobalisation

Two, the deflationary effects from China supplying cheap manufactured goods to the rest of the world and from falling trade barriers creating more efficient supply chains is behind us.

Sure, Chinese companies are competing ruthlessly, with seemingly little regard for profitability, to grab market share in emerging segments such as electric vehicles. Still, such unsustainable competition can be abruptly halted due to pressure from lenders or government intervention.

Meanwhile, America’s imposition of high trade tariffs on trading partners will create more fragmented and inefficient supply chains, which in turn drives prices higher for consumers in the US and globally.

Importantly, swingeing trade tariffs introduced by Trump appear irreversible as the tariffs become entrenched as a key source of government revenue.

In addition, if the US also applies hefty tariffs on the import of services, this will fuel further inflationary pressures in the US and elsewhere.

AI and populist politics

Three, the productivity gains and positive effects of lower costs of goods and services from the growing use and power of artificial intelligence (AI) might not be hugely significant.

Sure, much money is being invested to harness the power of AI. And it can potentially be a big game changer across many sectors. However, companies may face severe backlash from workers in using AI as workers fight to protect livelihoods.

Invariably, political forces can impede AI’s growing power. Think of populist politicians embracing costly moves to protect jobs and strengthen social safety nets to address the anxieties of populations who feel threatened by its rise.

Indeed, the increasing use of AI and its possible result of greater inequality may be met with hostile strikes and protests. 

Could AI’s backlash lead many governments to become populist, borrowing more and being punished by the market with higher debt costs?

Fading baby boomers

Four, the effects of the baby boomers, defined as those born between 1946 and 1964, driving demand for stocks and bonds in the US and Western Europe will fade as their numbers dwindle.

Many baby boomers in the developed world grew up well-educated and spent their working years earning good wages as well as enjoying job stability amid rebuilding of economies post World War II and moves to liberalise global trade. 

Should younger cohorts in the developed world fail to match the baby boomers in wealth accumulation because of job market instability and slow wage growth, less liquidity may flow into stocks and bonds, which in turn drives up equity and debt costs.

Gold and crypto

Five, while bonds remain a core component of investment portfolios, the weakening credit profile of many sovereign issuers coupled with rising geopolitical tensions, could push investors to hard assets such as gold and other precious metals instead of government bonds. 

At the same time, young people may increasingly embrace crypto investments. Might the mainstreaming of crypto investments divert substantial retail as well as institutional money away from bond markets?

For one thing, growing understanding and acceptance of crypto investments coupled with a stronger regulatory framework for such investments can create strong momentum in the crypto space.

Of course, if interest rates are much higher over the medium to longer term, the effects across different investment instruments will vary.

In the local equities market, real estate investment trusts for one could be badly hurt by higher interest rates. Many listed companies will also be adversely affected by interest rate hikes as higher borrowing costs hit bottom lines while higher cost of equity dampens share prices.

In addition, bond prices will fall given the inverse relationship between bond prices and interest rates.

Nonetheless, banks could gain from higher interest rates through fatter net interest margins.

While interest rate movements greatly impact investment returns, predicting interest rate changes is tricky.

Still, investors and businesses would be wise not to be lulled into thinking that low interest rates will persist. Ultimately, mega trends that are unfolding suggest the interest rate picture further out could be a lot different and possibly far less favourable for many investment instruments.