Growth and long-term interest rates near their low point
Financial markets reacted sharply to the revision of employment figures for the 12 months up to April 1 of this year. The data showed that employment in the U.S. had increased by only about half of what was initially reported. Since April 1, job growth has slowed even further, virtually flattening out. Markets immediately speculated that the Fed would implement more rate cuts than previously anticipated. As a result, interest rates fell across the board, equities and especially precious metals surged, and the dollar weakened. The key question now is: is this a gamechanger, and will these trends persist?
So far, GDP growth figures have not been revised, which means that productivity gains must have been higher. If this trend continues, it is certainly positive for growth, as the economy could expand further without fueling higher inflation. Stronger growth, in turn, would also help reduce the government deficit. However, one should be cautious in drawing conclusions, as the source of higher productivity remains unclear. It may stem from AI, which would bode well for the future, or from labor market tightness, which simply forces more output from the existing workforce—a temporary phenomenon.
Until recently, keeping inflation low was the top priority for most central banks, including the Fed. Now, however, markets expect U.S. rate cuts even as inflation picks up. This shift must be viewed against the backdrop of central banks—particularly the Fed—becoming increasingly wary of low growth or even recession. Weak growth is perceived as more dangerous due to ever-rising debt-to-GDP ratios and their potentially disastrous consequences for public finances. Growth, therefore, is gradually becoming the overriding priority.
A crucial question is: what is driving weaker employment? Is it lower economic growth, a labor shortage caused by the immigration freeze, or a sharp increase in productivity? If it is the latter two, then the economy does not require much stimulus right now. A labor shortage would even lead to higher wage growth and inflation. Only weak growth would justify stronger stimulus—at least if policymakers choose to overlook rising inflation. Some economists argue they should, since inflationary pressures are largely driven by tariffs, whose effects may fade over time.
For now, businesses have laid off relatively few workers—an indication that growth is not particularly weak. The Fed, however, fears this may change soon, leading to consumer purchasing power erosion and a downward economic spiral. To avoid this risk, the central bank appears set to lower rates this month.
Markets, however, are pricing in much more aggressive Fed action, discounting a series of rapid cuts through mid-next year. This would make sense if the economy remained weak, but there are few signs of that. More importantly, if growth does slow, it is not primarily due to high interest rates but to uncertainty created by tariffs. These still require Supreme Court approval, and it is likely that not all will be upheld—sparking extended legal battles. Until more clarity emerges, most trade agreements remain on shaky ground.
This suggests that stimulating growth through rate cuts will likely have limited effect and carries the risk of overheating the economy—especially since fiscal stimulus in the U.S. will also kick in strongly early next year.
Our conclusion: given the current outlook for growth and inflation, there is no justification for a series of aggressive rate cuts. While we understand the Fed’s caution, a rapid cycle of cuts would likely come at a high cost later in the form of sharply rising inflation—a risk already reflected in precious metals markets.
We believe U.S. long-term interest rates are now close to their bottom and will soon begin to rise. The same holds for European long-term rates, as Europe also appears to be approaching a trough in economic growth thanks to fiscal stimulus. However, given Europe’s much lower inflation risk, the rise in long-term rates there is likely to be more moderate than in the U.S.
