It is hard to read the tea leaves when it comes to interest rates. But I was struck by two recent news items, both in Bloomberg, that seem to show that interest rates may face upward pressures.
The first was an article on how France and Germany have huge borrowing requirements, to finance the fiscal expenditures that were instituted to fight the COVID-related depression. These huge borrowing requirements are putting upward pressure on yields. You will note that even though yields there have risen in the last two months, they are still extremely low by historical standards. It is not the magnitude of the rise that causes me to report on this, rather it is the cause of the rise, which seems linked to unusually high borrowing requirements. This is likely to continue, and to put pressure on yields.
The second was a similar item, related to the Reserve Bank of India. It seems that in India too, yields have been rising, for slightly different reasons. Here it seems policymakers are worried about inflation, and may be letting yields rise rather than printing more money to keep them down.
When I was learning economics in the 1990s, a very popular story for why public deficits were bad for growth had to do with crowding out. Crowding out was a story based on supply and demand. The story was that when the borrowing requirements of the public sector were high, interest rates would tend to rise as a result of the demand for loanable funds emanating from the government. In turn, these rising rates would raise the cost of capital to the private sector, depressing private investment. In this manner, public spending would "crowd out" private investment, reducing growth.
The crowding out story kind of disappeared from the economics lexicon in the 2000s. During the Great Recession, central banks injected massive amounts of liquidity to shore up the banking sector and avert a depression. New terms like quantitative easing, whereby central banks would purchase all sorts of assets besides government debt, in exchange for newly-created money balances, meant that interest rates could fall all the way to the lower bound (zero) even in the presence of large public deficits. Inflationary pressures were tame, so central banks could do this without fear of igniting generalized increases in the price level. But with the COVID pandemic, we are testing the limits of this process. The borrowing requirements are so huge, and the amounts of injected liquidity so enormous, that we may get either inflation or rising interest rates.
Of course, we are not there yet, and it could take months, maybe years, for this to become a serious concern. But I am flagging it now because we are possibly seeing some early signs of the reemergence of crowding out. This is not yet the case in the US, and in most countries. But it is showing up a bit in Europe, in India... and the economic mechanisms that make these concerns valid there make them potentially valid elsewhere, because governments everywhere are running unprecedented deficits. I doubt that we will continue to be able to monetize massive amounts of public debt without paying - at some point - the consequences in terms of growth and inflation.
UPDATE: A few days after I posted this, the Fed made an announcement that they would likely keep rates near zero for the next 5 years, and that they would relax their stance toward inflation. This seems to go counter to the two articles I linked to above. I have some observations: if growth resumes and inflationary pressures appear again during the recovery, the Fed may not be able to maintain their new stance: if inflation rises, the Fed will have to do something about it, and that something may involve a departure from zero rates. In that case, the policy will have proven to be time-inconsistent, leading to a loss of credibility for the Fed. But if the Fed fails to convince firms and consumers that they are committed to low rates for a while, people may not act to restart the economic engine by consuming and investing: the Fed is between a rock and a hard place (as it usually is!). There is also the possibility that if rates elsewhere rise, the Fed may face the prospect of a dollar depreciation, and consequently may be forced to soften its stance on low rates. The Fed typically does not target the exchange rate, so this may be a weak channel for rising rates, but if combined with domestic inflation, it may contribute to a departure from the announced policy stance. I'm not saying this will necessarily happen or that rates will rise for sure, I'm only thinking through one possible scenario. And by making this announcement, the Fed sure is indicating that they believe we will be in this slump for a long time - if anything I take this as an indication of the seriousness of our current economic predicament.