The end of cheap

Growth in America over the past 50 years or so has been predicated on cheap everything: cheap capital, cheap labour and cheap energy. We are seeing the end of that era. Photo by Tevordohlib/Getty Images

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Expectation inertia is a powerful force. Thirty-year Treasury yields went above 5 per cent in 2023 before heading back down. But in the last couple of weeks, as the same thing has happened, investors finally seem to be accepting the notion that America is leaving the era of lower interest rates, and entering a new world with many more inflationary vectors than in the past.

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There are multiple reasons for this — from higher energy and goods prices related to war and tariffs, as well as re-industrialisation and rising defence spending, to the way in which AI giants are gobbling up real estate, chips, water and electricity, raising the price of these things across the economy at large. Lower demand for all those United States Treasuries doesn’t help either.

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Then there are the slower drip issues such as rising debt, geopolitical strife and populism. These risks mean that lenders want a higher premium for shelling out their money over the next few years.

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Taken together, the message is clear. “Investors should position for a persistently higher rate environment” for the short, medium and longer term, according to a recent client note from Apollo chief economist Torsten Sløk.

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Put another way, we are seeing the end of an era: the era of cheap. Growth in America over the past 50 years or so has been predicated on cheap everything: cheap capital, cheap labour and cheap energy. All the major geoeconomic and geopolitical dynamics supported these things.

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Thirty-year Treasury yields, for example, fell for almost half a century until quite recently, going from the mid-teens in the early 1980s to around one per cent during the pandemic. Former U.S. Federal Reserve chair Paul Volcker kicked off that era with the monetary tightening that began in 1979. But the trend kept going because all the big macroeconomic vectors supported it.

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Decades of globalization and technological advances in manufacturing reduced the price of goods. A flood of petrodollars (cash from oil-exporting countries) into the U.S. created new and plentiful supplies of cheap money. The privatization of retirement systems created a bigger demand for all sorts of new financial products, which Americans poured money into. Foreign borrowers wanted more U.S. Treasuries because what country was a safer place to park your money than America?

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All those vectors have now changed or are changing.

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Each Treasury auction brings fewer international buyers, rather than more. Decoupling and the move of the U.S., Europe and others around the world to bring at least some of their critical industrial capacity back onshore will probably raise the prices of goods and services in the short to medium term (though it may also increase resilience in the long run).