Markets need to adjust to a new economic reality where chronically weak demand, persistent disinflation, and negligible interest rates are no longer the norm, according to Helen Thomas. This shift comes as government bond yields have seen a relentless rise since investors returned from their summer holidays.
Factors contributing to this repricing include the potential for persistent disruption in the Strait of Hormuz, which could sustain inflationary pressures, and a surge in bond supply from governments and AI hyperscalers. Increased political risk has also played a role.
Despite alarming headlines about bond yields reaching multi-decade highs, equity markets have remained buoyant. This may not be a contradiction if higher inflation is accompanied by stronger growth driven by company investment and innovation. New York Fed President John Williams suggested strong equity markets could reflect investors capitalising on profits from a few dominant companies with pricing power.
Policymakers are now sending a clear message that investors must adapt. The central bank's role is not simply to provide a low, risk-free rate to sustain asset prices; price stability is a key mandate. Fed Chair Kevin Warsh noted this month that broad financial conditions were not restrictive when the Fed increased interest rates, describing it as easing off the accelerator rather than slamming on the brakes.
The current economic environment is characterised by heavier government debt burdens, more frequent geopolitical shocks affecting supply, and the need to finance defence, energy infrastructure, and the AI revolution. Technology may also be increasing the economy's productive potential, suggesting a more capital-intensive, faster-growing economy where the equilibrium price of money is structurally higher.
Credit markets are already showing signs of this adjustment, with spreads between borrowers widening. Oracle, for instance, has seen the cost of insuring its debt through credit default swaps reach record highs due to its borrowing for data centre construction.