How far is it possible for the interest rates to go up?
The FEDs have been raising interest rates very aggressively since April of 2022, that is 15 months as of today. The FEDs are doing so based on their mandates, of maximum employment and price stability. And at this point these two mandates seem to be contradicting each others. Inflation is running high and the way to reduce it, according to the FEDs, is by eroding the job market, i.e. increase unemployment.
However in the background there are many other factors that weigh in on the rates. One of them is the national debt, long term rates multiplied by the national debt is what the US government has to come up with to pay the interest (just the interest) on the debt. The later is over $32 Trillion as of today. And each 1% of interest rate is equal to $320 billions.
We have also seen how the fast increase of the interest rates had caused many banks to collapse due to reduction of their "collateral" caused by miss management of bond maturity in their portfolios.
The interest rates also impact financial markets. For example, the current P/E ratio of the S&P (most commonly used index) is just above 25. That makes the rate of returns on the S&P stocks about 4%. It is very hard for investors and portfolio managers to justifying taking the risk of buying stocks while the 1-year treasury is paying over 5% today (as of 7/1/2023 the yield curve is severly inverted and the 1 year pays 1% almost more than the 30-year treasury bond). So the risk-free returns(stocks return - treasury returns) is effectively negative now.
We are in a unique time indeed, in the sense that for the last 40 years, the 30-y treasury has been on a constant decline, as shown in the graph below. They say "History might not repeat itself but it rhymes." However, we have not seen inflation as high is it has been the last two years since the late 90s as well.
