The future of interest rates is a topic of concern for many, especially with the recent appointment of Kevin Warsh as the new chair of the Federal Reserve. While President Trump has called for sharp interest-rate cuts, the long-term trend suggests otherwise. Rising interest rates are a natural economic phenomenon, and there's little politicians can do to prevent it. The COVID-19 pandemic temporarily paused this trend, but it won't last forever. From 1990 to 2016, a secular decline in nominal interest rates was driven by positive baby boomer demographics, decelerating inflation, declining taxation, and positive geopolitical developments. However, since 2016, things have changed. Baby boomer demographics are now negative, inflation is accelerating, and higher taxation is expected due to record-high government debts and deficits. This shift is a result of long-term trends, not cyclical developments. The real interest rate trend is influenced by factors like technology and demographics. Demographic changes, such as the retirement of baby boomers and the de-saving years, reduce the supply of funds while increasing demand for capital from corporations and governments. This demand-supply imbalance pushes the real interest rate higher. Similarly, secular inflation is on the rise due to factors like the retirement of experienced baby boomers, leading to higher wage demands, and the need for higher taxes to fund pandemic-related deficits and debts. Other structural changes, such as deglobalization, will also contribute to higher inflation in the long run. Despite the potential benefits of AI in productivity and profit margins, it may not significantly impact inflation or interest rates. AI's hypothetical productivity boost is offset by its increase in capital demand, which pushes up real interest rates. This could have serious implications for growth stocks, which may face a similar fate as the Nifty Fifty growth-stock darlings of the 1960s. As interest rates rise, these stocks' unrealistic growth expectations may be punished, underperforming the broader market averages.
