Painfully high rates a wake-up call that threaten markets around globe
Investors see U.S. rates staying as high as 4% in the long term; stocks, risky corporate debt still trading on low rate view; analysts warn of valuation slump on elevated U.S. rates; money managers seek shelter in emerging markets, bank stocks; markets ar
ear that interest rates in major economies will stay relatively high is creeping back and threatens a painful wake-up call for nancial markets, big investors warn. With traders laserfocused on expected summer rate cuts, global stocks remain near record highs and demand for debt issued by the riskiest companies is rm.
But asset managers and economists now expect only minimal monetary easing, especially from a U.S. Federal Reserve facing unexpectedly persistent ination.
Big investors are not rushing to change longterm holdings, but in a sign of things to come stock market volatility is around a six-month peak as traders debate how high the U.S. rate hurdle against which nancial assets are valued will stay.
FValuation drag
Global stocks will su er “a valuation drag from higher for longer rates,” said Ann Katrin-Petersen, senior investment strategist at the BlackRock Investment Institute, the research arm of the world’s largest asset manager.
Amundi, Europe’s largest asset manager, said in a note on Monday U.S. stocks will lag globally for the next decade. It expects equity and debt of companies in developing nations such as high-growth India and mineral-rich Chile and Indonesia to outperform.
“Everyone is so focused on when rate cuts are coming,” BNY Mellon chief economist Shamik Dhar said. “The much bigger question is what is the average level we can then expect rates to cycle around.”
Traders, who since 2009 have become used to low rates attering asset prices, are set for “an adjustment in expectations, psychology and beliefs”, Mr. Dhar added.
The International Monetary Fund said Fed funds rate could fall more slowly than markets anticipate.
BlackRock’s Petersen forecasts U.S. rates of close to 4% for the next ve years and about 2% for the euro zone. “We have entered a new macro-market regime and one of the cornerstones of that regime is structurally higher rates.”
World stocks are up about 4% this year, hitting record highs in March. And an index of global junk bonds issued by indebted rms is around its highest since 2021 , bolstered by hopes the Fed will lower rates from a 23-year high of 5.25% to 5% keeping global borrowing and investment conditions exuberant.
‘Reassess discount rate’
But up for reassessment is the discount rate investors plug into company valuation models, which follows long-term U.S. rate expectations. A one percentage point rise in this yardstick depresses the present value of rms’ future earnings by 10%, EY estimates. Stock prices, especially U.S. ones, are too high, investors said.
Wall Street’s S&P 500 index, which inuences equities worldwide, is priced 32% above fair value based on long-term rate forecasts, says Vanguard, the world’s second largest money manager.
“When you do the global return exercise, the 10year exercise, future returns are (going to be) less than what we’ve had, mathematically,” said John O’ Toole, head of multi-asset solutions at Amundi.
Higher discount rate
Ten-year Treasury yields, at around 4.5%, already predict a higher discount rate.
Risky assets are holding up partly because the cost of capital that investors plug into company valuation models reects cheap loan rates agreed previously, Vanguard senior economist Qian Wang said.
With U.S. rates expected to settle around 3.5% and a wave of corporate renancing coming in 2026, she added, “investors will be disappointed”.
Trading the shift
Ageing populations, a shrinking workforce and Western economies reshoring production from China are expected to keep ination and rates elevated.
Escalating West Asia conict has pushed oil near $90, as ongoing climate shocks threaten to keep commodity prices high. Markets are pricing fewer than two Fed rate cuts this year.
The rst European Central
Bank cut is priced for June, but traders have reduced bets for how far it can go.
BlackRock’s Petersen said the group was neutral on stocks, preferred ination-linked debt and viewed long-term government bonds as vulnerable to volatile ination.
Tom Lemaigre, who manages about £7.7 billion ($9.58 billon) worth of European equities at Janus Henderson, said he may add to positions in banks, which do well from high interest rates.
He has also turned more positive on European industrial exporters that benet from a strong dollar and the U.S. expanding domestic manufacturing.
The shift towards high long-term rates becoming embedded in traders’ thinking is “yet to come”, Lemaigre added.
Asset managers and economists now expect only minimal monetary easing, especially from a U.S. Federal Reserve facing unexpectedly persistent ination
Volatility rises
Still, the closely-watched VI◣ gauge of U.S. stock volatility has marched up to a reading of about 19 after slumbering for at ultracalm levels for months while the comparable bond index is moving higher, as unease grows.
“If markets move from the thinking there will be two (Fed) cuts, to one then to (predicting) a hike, it will be really hard for the equity markets to survive that,” said Richard Dias, strategist at PGM Global.