It's a 5% world. We're just living in it

For years, borrowing money came at rock-bottom costs, fueling a period of economic growth from 2008 to 2021. However, the cost of borrowing is now rising steadily, with significant consequences for individuals, businesses, and the U.S. government's finances. The bond market has pushed most risk-free interest rates above the 5% mark, a shift that could lead to pain in sectors like housing and increase risks of financial disruption.

While it is a boon for savers who can now invest safely with higher returns, it is an era of expensive borrowing and depleted capital that lasted from 2008 to 2021. The Federal Reserve, once in charge of setting policy rates, now appears out of position, believing they've set rates too low to control inflation amid economic growth, and may adjust course.

The surge in rates is primarily due to a rise in real yields, reflecting a stronger growth outlook rather than an increase in expected inflation. Investors can now purchase a 30-year inflation-protected Treasury security yielding 3.26%, the highest since 2002. The forward earnings yield of the S&P 500 stands at around 5%, making bonds more attractive compared to stocks.

As a result, 30-year fixed-rate mortgages are expected to reach near 8%, up from 7.45% in recent weeks. This sharp increase could create a housing market standstill, with people unable to afford homes and sellers unwilling to cut prices. The U.S. government's debt service costs were projected to reach new highs, but if the rate surge persists, the burden will be even greater.

By 2056, debt held by the public could reach 222% of GDP in a scenario where interest rates are 1 percentage point higher than the CBO's baseline, up from 196% in the baseline projection. Higher interest rates will necessitate a reevaluation of fiscal policies, asset prices, and overall views on normalcy in an age of global capital demand.