Higher Economic Growth = Higher Long-Term Interest Rates!

International bond markets are currently receiving a great deal of attention: long-term interest rates on 10-year and 30-year government bonds are rising across the Western industrialised countries. In the meantime, they have reached their highest levels of the past five years.

What is behind this upward trend? The financial media consistently point to Western governments. They are accumulating debt and facing large budget deficits. As a result, lenders are demanding a higher price (= interest rate) because they fear that the risks are increasing.

But is the high debt burden of the Western industrialised countries really the reason behind the rise in interest rates? Wasn’t there also excessive debt five to ten years ago? And didn’t long-term interest rates fall during that period?

We believe that strong economic growth provides an explanation for the rise in long-term interest rates. Economic research has shown that there is a close correlation between economic growth and the evolution of long-term interest rates.

Let us first take a look at the current state of the global economy. Graph 1 shows the development of global business confidence (blue line, Global PMI Output Index). This economic indicator is published monthly and is based on a survey of tens of thousands of business leaders worldwide. When the indicator is above 50 points, the economy is considered to be expanding. A figure below 50 points indicates a contraction in international economic activity.

The past few months have seen a sharp increase in global business confidence. This means that an increasing number of business leaders are becoming more optimistic about the economic outlook, leading them to invest more and create more jobs. As you know, this combination supports economic growth.

Graph 1 shows the close correlation between global business confidence and global economic growth. Based on the current level of global business confidence, we can reasonably expect global economic growth of around 3% to 3.5%. We have not seen this level of growth in recent quarters, and it is also the reason why, at this point, we do not expect a global recession.

Graph 1: Global economic growth vs. business confidence

Source: S&P Global PMI

The second graph illustrates the second part of our argument. There is a very close relationship between the growth rate of the global economy and the level of long-term interest rates.

US economic research has shown that stronger US economic growth leads to higher US long-term interest rates. We see no reason why this effect should apply only to the United States.

According to our analysis, it is therefore not high government debt, but rather the acceleration in economic growth that is driving long-term interest rates higher.

And this acceleration in economic growth is actually good news for Western governments. It means higher tax revenues, which in turn could eventually lead to a decline in long-term interest rates.

Graph 2: US economic growth vs. US 10-year Treasury yield

Source: Deutsche Bank Research Institute

Conclusion

In our view, the current turmoil in international bond markets is not the result of concerns about the debt burden of the Western industrialised countries. On the contrary, we attribute it to accelerating economic growth, which will generate higher revenues and, in this way, benefit national government budgets.