The crash that no one talks about: What are the consequences of higher prices? – finance

Since last fall, bond prices have risen. This worries markets and families.

This is one of the consequences of inflation: interest rates are rising. The yield on Belgium’s 10-year bond, which was still zero at the end of the year, is now around 1.4%. The rally is general: In the US, the yield on 10-year government bonds rose from 1.5 to 3% in less than four months. It can go on. “The sharp rise in long-term interest rates since the start of 2022 is linked to the expected rise in inflation, and the increasingly aggressive rhetoric of central banks that claim they want to fight inflation,” notes Natixis Chief Economist Patrick Artus. . “The question is whether or not long-term interest rates will rise to the level where it is possible to talk about interest rate normalization,” he adds. Normal rates, corresponding to the tense economic situation but without overheating, would be around 3% in the Eurozone and 4.5% in the United States. We are still far from that.

This is one of the consequences of inflation: interest rates are rising. The yield on Belgium’s 10-year bond, which was still zero at the end of the year, is now around 1.4%. The rally is general: In the US, the yield on 10-year government bonds rose from 1.5 to 3% in less than four months. It can go on. “The sharp rise in long-term interest rates since the start of 2022 is linked to the expected rise in inflation, and the increasingly aggressive rhetoric of central banks that claim they want to fight inflation,” notes Natixis Chief Economist Patrick Artus. . “The question is whether or not long-term interest rates will rise to the level where it is possible to talk about interest rate normalization,” he adds. Normal rates, corresponding to the tense economic situation but without overheating, would be around 3% in the Eurozone and 4.5% in the United States. We are still far from that. For economists, rising prices accompanying rising inflation is not the end of the world. “By separating the nominal interest rate from the real interest rate, which is the rate corrected for ‘inflation,’ we are changing the perspective,” notes Etienne de Callataÿ, professor at UNamur and chief economist at Orcadia. If we compare the situation today with the situation a year ago, yes, nominal interest rates are higher. But so are inflation expectations. So the real rate is not much higher today than it was yesterday.” The European Central Bank already expects inflation to jump to 5.1% this year but fall to 2.1% in 2023 and 1.9% in 2025. Taking into account inflation that It would be around 2% in the long run, a 10-year nominal rate of 1.5% meaning the real rate is still negative at -0.5%. Etienne de Callataÿ continues: “Economic agents have to rely on real interest rates. If you have to pay a high interest rate on your bank loan but there is significant inflation and your salary is also increasing a lot, where is the problem?” Similarly, even in an environment with higher rates, “A company can borrow for investment because it will tell itself that its selling prices will rise and that it will be able to On passing this inflation in their selling prices,” adds economist. Orcadia. Two economists state in a recent blog of the International Monetary Fund that higher interest rates have advantages. It allows, for example, to avoid falling into the liquidity trap, which is the trap that occurs when Rates are so low that most households and businesses would rather hold cash than buy debt – which results in nothing. But without investor support for borrowers, it becomes difficult to restart the economic machine. But the big drawback of high rates is that it instills anxiety and uncertainty. , which does not benefit the economy at all but can lead to political instability.” Some consumers are victims of what Keynes called the monetary illusion, notes Etienne de Calata. When they borrow, they prefer a 1% interest rate when inflation is zero rather than 3% rates when inflation is at 5%. As a borrower, the latter situation is less painful.” But this illusion is well entrenched. “The news of inflation appears to have dire consequences for presidential approval rates and election results,” wrote Robert Schiller, the 1997 Nobel laureate in economics. It remains a constant concern of the population. Because, along with what might be a misjudgment, people’s concerns are also based on very real elements: if inflation and interest rates rise, wages or income will not necessarily follow the same proportions, nor immediately.” If we expect More inflation in the next 20 years, rates will go up but you’ll have to pay more on your loan next month when your paycheck is just five years away. This time period may be a problem for the family or a company.” “But this is not for the state,” adds Etienne de Calatache: “If there is too much inflation and if rates do not rise proportionately, the state is the winner because this reduces the real value of its debt stock and this It allows it to finance itself on an economic basis that grows faster than interest rates.” If the effect of an interest rate hike does not worry economists, it makes financiers nervous. Because a price hike is also a drop in current bond prices. Since the beginning of the year, the Belgian bond price has fallen for a period 10 years at more than 10%.” In financial markets, this bond crash is reminiscent of what happened in 1994, notes Frank Franken, chief strategist at Edmond de Rothschild (Europe). At that time, in the US government bond market, we observed a correction of 17.9%. Today it’s 17.2%. This is a very big correction. However, this collapse should not destabilize the financial system, as Frank Franken irrits. “Companies that, like insurers, are under no obligation to reflect the evolution of the market value of their portfolios of bonds in their results because they hold these bonds until their term, suffer Certainly a serious loss of profit (the bonds in their portfolios yield less than those companies can buy today) but they are less sensitive to market fluctuations, while others, such as banks, suffer losses in their accounts, but they can also invest their new reserves in new bonds which provides a higher return, and therefore the results will not be affected catastrophically.” In fact, the most difficult shock to the markets was observed. Because this bond collapse is fueling the thaw in the stock market for many companies. The government bond rate is used to calculate the value of the company. 100 euros today is not the same as collecting it in 15 years. To calculate the value of the company taking into account this loss, we rely on the rate of government loans. The higher the rate, the greater the loss.” As prices rise, valuations collapse, Frank points out. Franken. Investors no longer want to pay the same price for shares.” This explains the sharp decline in some tech stocks. “We’re not talking about giants like Apple, which have big margins, repeat business, and tens of billions of cash on their balance sheet, but promising companies, which It has little or no profit today but expects a lot more in a few years, Frank Franken adds: Some Nasdaq companies are down more than 40% since the beginning of the year.

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