The US Federal Reserve has raised benchmark interest rates by 5% since spring 2022 and the market is now expecting US interest rates to rise by a further half a percent over the course of the year. Although inflation rates have been on a steady downward trajectory since August 2022, they are still well above the Federal Reserve’s target of 2%. Rising interest rates are supposed to dampen economic growth, thereby countering inflationary pressures. The problem, however, is that there is always a lag of 12 to 18 months before this effect materialises and so the extent of the desired dampening effect on the economy is not yet foreseeable. We experienced the first side-effects of the massive rise in interest rates back in the spring when several US banks suddenly exhibited liquidity problems and had to be rescued by the central bank, with the side-effects then culminating in the demise of Credit Suisse. Since then, though, interest rates have continued to climb worldwide and, as communicated by the central banks, are set to rise further over the near term. The massive loans on commercial real estate are a particular risk to banks at present.

The economic data published over the past few months were surprisingly robust and stand in stark contrast to the negative expectations of most economic analysts. Probably the most important indicator is the US labour market, which is now weakening considerably despite all the glossing-over of the issue by central banks and politicians. In combination with further interest rate rises and even higher levels of debt, this is likely to have a negative impact on financial market sentiment over the coming months.

In a normal economic environment, long-term interest rates are always far higher than short-term rates. But interest rates on 10-year US Treasury bonds currently stand at 4%, as opposed to the 5% on 2-year bonds, a phenomenon experts refer to as an ‘inverted yield curve’. Such scenarios have occurred six times since 1981, leading to an economic slump in all cases bar none.