(Bloomberg) — Former Treasury Secretary Lawrence Summers warned that the assumption embedded in the bond market that the era of low interest rates — anchored by disinflationary pressures — is coming back is likely to be wrong.
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“I suspect tumult” for markets in 2023, Summers told Bloomberg Television’s “Wall Street Week” with David Westin. “This is going to be remembered as a ‘V’ year when we recognized that we were headed into a different kind of financial era, with different kinds of interest-rate patterns.”
A raft of indicators in the bond market, as well as long-run projections from the Federal Reserve, suggest widespread expectations for the same drivers that held down inflation before its recent surge to return, Summers said. He cited:
- Ten-year Treasury yields, which have averaged about 3.7% the past three weeks. That’s on par with the average of 3.89% over the past three decades.
- The Fed’s median forecast for the long-term real federal funds rate is 0.5% — reflecting forecasts for 2% inflation and a 2.5% policy rate.
- The US 10-year breakeven rate, one gauge of longer-run inflation expectations derived from the spread between regular 10-year Treasury yields and those on 10-year inflation-linked notes, is little more than 2%.
Those assumptions are likely to be wrong, Summers said — “Just as those who, during the Second World War, predicted that when the war ended, we would return to secular stagnation and a sluggish, low-interest-rate economy, turned out to be wrong.”
Summers, a Harvard University professor and paid contributor to Bloomberg Television, highlighted a number of shifts that suggest the pre-Covid secular stagnation pattern won’t return.
Fiscal deficits and the government debt load are likely to be enlarged on a continuing basis, thanks in part to expanded spending on national security. Investment outlays are also likely to be stronger, with the efforts to bring production back to the US and increase resilience in supply chains. The global “green-energy transformation” will also help mop up savings, according to Summers.
Meantime, the dynamic of workers from China and other emerging markets joining the global economy — serving to depress price pressures — has now run its course, he said. Add in increases in uncertainty, and investors are likely to demand higher premiums for risk, he said.
Former IMF chief economist Olivier Blanchard has made a contrasting argument, seeing reasons why three key drivers of low rates are likely to remain in place going forward. Demographic trends mean that savings rates are likely to remain high, and there’s probably still going to be strong demand for the relative safety of government securities, he argues.
While a big wave of spending on green technology to combat global warming could possibly send rates higher, Blanchard, a senior fellow at the Peterson Institute for International Economics, still concludes they would remain “fairly low.”
Summers agreed that such forces of secular stagnation are “strong” and that that scenario might play out, but ultimately judged that such “orthodoxy” will be proved incorrect.
Turning to the December US jobs report, the former Treasury chief said that evidence of a slowing in wage gains was “encouraging,” and the strength in employment expansion adds to evidence that the timing of a US recession has been pushed back.
“But I think the judgment that soft landings are the triumph of hope over experience continues to be the right best guess,” he said. “I’m not sure that continued strength points to a softer landing, rather than pointing to even a harder landing when things re-equilibrate.”
Summers reiterated his praise for Fed policymakers’ hawkish shift over the past several months. He also repeated that the central bank should follow through on its signals of raising rates further and keeping rates high for some time to quell inflation.
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