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Why Are US Interest Rates High and Rising?

New savers in the United States stand to gain as returns on savings – which have been subject to severe financial repression for most of the last decade – begin to rise. But higher interest rates could leave homeowners and shareholders vulnerable to losses.

CAMBRIDGE – Long-term interest rates in the United States are rising, and are likely to continue heading up. Over the past 20 months, the yield on ten-year Treasury bonds has more than doubled, from 1.38% to 2.94%. Why is this happening?

About half of the 1.56-percentage-point rise is attributable to an increase in the real interest rate, as measured by the inflation-indexed ten-year Treasury bonds, whose expected real yield has risen from zero in July 2016 to 0.82% now. The other half of the rise in the interest rate reflects the increase in the expected rate of inflation from 1.38% to 2.12%.

High and rising interest rates have important effects on the economy, especially on the prices of stocks and of homes. Because extremely low interest rates during the past decade caused equity prices to rise to unprecedentedly high levels, the shift to higher interest rates will slow and depress share prices. The level of real interest rates is particularly important for share prices, because higher inflation raises nominal profits in a way that offsets the inflation component of higher interest rates.

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