Real interest rates were fairly negative before the summer and have since declined further as a result of persistent high inflation and a decline in nominal (long-term) interest rates. Negative real interest rates are generally a positive for financial markets and economic growth, as they make it appealing to borrow and use the money for investment. In addition, debts will weigh less in real terms. This has a positive impact on assets such as equities and property, and it exerts downward pressure on credit spreads.

However, real interest rates should not decline too rapidly, as this could be interpreted as a sign that economic growth will fall back considerably.

It is not immediately clear whether the markets interpret negative and declining real interest rates as being positive or negative. On the one hand, equity and house prices have stayed under upward pressure, and credit spreads have faced downward pressure. This indicates investor optimism.

On the other hand, the decline in real interest rates had coincided with falling commodity prices, a flattening yield curve and a decline in nominal long-term interest rates. These are all signs of declining growth.

Low real interest rates could have several possible causes. This makes it difficult to interpret what they are telling us.

First of all, bond investors may anticipate a considerable decline in economic growth and inflation due to the surge in corona cases and the expectation that the impact of fiscal policy on economic growth will shift from a strong stimulus in recent quarters to a considerable decline over the next few quarters.

The Delta variant has been spreading rapidly, while many people have not yet been vaccinated. Moreover, fully vaccinated people can also transmit the virus and the vaccines offer far less protection after about six months. Booster vaccines will probably offer (sufficient) additional protection. However, it will take a while before everyone has received this booster. In the meantime, concerns about the pandemic could slow down economic growth and many economic data could prove weaker than anticipated.

At the same time, several structural negatives for growth – ageing populations and soaring debts – have strengthened. Finally, inflation has been rising faster than wages in many countries, which affects purchasing power (and consumer confidence).

The above facilitates a scenario in which the economy has been experiencing a boom due to vaccinations and large-scale fiscal stimulus, but that a bust is in the cards. Concerns about deflation could resurface by then, prompting central banks to (further) ease monetary policy.

The decline in real interest rates over the summer could also be due to temporary factors that don’t reflect underlying economic strength:

• In spite of high inflation, the Bank of Japan and the ECB have announced that they will not raise their rates in the coming years. The Fed is considering pursuing a less loose monetary policy, but it will remain very accommodative for the time being.
• Over the summer, the US government has withdrawn and spent vast amounts of money from its Fed account. This has resulted in a considerable amount of additional liquidity in the economy, on top of the money that the Fed pumps into the economy every month. This has exerted even more downward pressure on interest rates. The government will continue to withdraw money from its Fed account until Congress raises the debt ceiling. This could increase downward pressure on interest rates and reinforce upward pressure on asset prices. However, once the debt ceiling is raised (this is expected by November at the latest), analysts believe that the government will raise the amount in this account by issuing debt securities, thereby removing net liquidity from the market, which will exert upward pressure on interest rates.
• Real interest rates have also been depressed by problems and disruptions on the supply side of the economy. The labour market has been disrupted by the corona crisis, as a result of which many companies are struggling to recruit sufficient staff. This has also disrupted supply chains, resulting in a shortage of computer chips, while (sea) transport takes longer and is far more costly. This has exerted more upward pressure on prices. At the same time, economic growth is depressed, as companies cannot produce as much as they want. However, it is assumed that many of these problems will gradually disappear. This will give economic growth a boost and will depress inflation. Base effects also play a role in the latter.

We believe that the decline in long-term nominal and real interest rates has been mainly due to the temporary factors. Growth is unlikely to decline to the extent where concerns about deflation resurface and where monetary policy ends up even looser than now.

Growth is likely to fall back, but this will largely be due to mounting concerns about the corona variants, less fiscal economic stimulus and problems on the supply side.

However, more concerns about covid variants will also result in a higher vaccination coverage. There will still be major problems on the supply side, but they will gradually decrease. If more people are vaccinated, more people will return to the labour market. In addition, we believe that companies will have partly solved the supply chain problems in a few months from now.

In the coming quarters, economic growth will be slowed down by fiscal policy. On the other hand, job growth will increase, and consumers will still have considerable savings and healthy balance sheets will give them more scope to borrow. In other words, (consumption) growth could persist, even in the absence of looser fiscal policies. In addition, we believe that companies will step up investment activity to catch up on investments that were shelved last year, and to reduce dependence on long supply chains and scarce staff.

In conclusion, we anticipate persistent downward pressure on economic growth in the months ahead, but growth is set to pick up in the ensuing period. We anticipate a similar scenario for inflation. Inflation will initially come under more downward pressure due to decreasing base effects and the gradual disappearance of problems on the supply side in a few months from now. However, inflation will subsequently end up at levels higher than before the corona crisis, as an ever larger proportion of surplus money created by central banks will flow to the real economy. This is due to, on balance, persistent high public deficits. Another reason is that households will spend more of their savings.

Based on the above, we have the following expectations:

• Nominal interest rates will not rise significantly in the short term, but they will rise in subsequent quarters.
• Expectations of a less loose Fed policy will fade in the coming months, after which they will increase; by that time, we also anticipate more speculation on Fed rate hikes as a result of relatively high inflation (expectations) by that time.
• Real interest rates are unlikely to decline to far lower levels in the months ahead and they are likely to rise in the ensuing period.