Concerns are mounting that high interest rates in key global economies could persist, potentially jolting financial markets, according to major investors. Despite expectations of rate cuts this summer, global stock markets are hovering near all-time highs, and there's strong demand for bonds from high-risk issuers.
Asset managers and economists are now forecasting only slight monetary policy easing, particularly from the U.S. Federal Reserve, which is grappling with stubborn inflation. While major investors have not yet adjusted their long-term investment strategies, the possibility of sustained high U.S. interest rates has led to increased stock market volatility, reaching a six-month high.
Experts from BlackRock Investment Institute predict that "valuation drag from higher for longer rates" will impact global stocks. Amundi, the largest asset manager in Europe, anticipates that over the next decade, U.S. stocks will underperform compared to equities and debts from emerging markets, including India, Chile, and Indonesia.
Attention is heavily focused on the timing of rate cuts, overshadowing the more critical question of the average rate level going forward. Since 2009, traders have become accustomed to low rates boosting asset prices, but an adjustment in expectations is imminent, according to BNY Mellon's chief economist.
The International Monetary Fund suggests that the Fed funds rate may decrease more slowly than market expectations. BlackRock forecasts U.S. interest rates to hover around 4% for the next five years, with the euro zone rates at about 2%, indicating a shift to a new market regime characterized by structurally higher rates.
Despite a 4% increase in world stocks this year and global junk bonds reaching their highest point since 2021, the reassessment of the discount rate used in company valuations is due. A one percentage point increase in this rate could reduce the present value of future earnings by 10%, according to EY.
Investors argue that U.S. stock prices are inflated, with the S&P 500 index valued 32% above its fair value based on long-term rate projections. Vanguard highlights that the anticipated returns over the next decade will likely be lower than previous years.
Risky assets remain stable due to previously agreed upon low loan rates. However, with U.S. rates expected to stabilize around 3.5% and a significant amount of corporate refinancing on the horizon in 2026, investor disappointment may be inevitable.
Factors such as aging populations, diminishing workforces, and the reshoring of production from China to Western economies are expected to maintain high inflation and interest rates. Additionally, geopolitical tensions and climate-related events are contributing to elevated commodity prices.
Market expectations for Fed rate cuts have diminished, and the European Central Bank's first rate cut is anticipated in June, though expectations for its extent have been scaled back. BlackRock adopts a neutral stance on stocks, favors inflation-linked debt, and views long-term government bonds as susceptible to inflation volatility.
European equity managers are considering increasing their positions in sectors that benefit from high interest rates, such as banking, as well as industries that gain from a strong dollar and U.S. manufacturing growth. The market has yet to fully adjust to the prospect of enduring high interest rates, indicating potential challenges ahead for equity markets if predictions shift from rate cuts to increases.
