Since October, when Donald Trump took the lead in US election betting markets, global borrowing costs have been trending upwards and last week UK 10-year gilt yields and 10-year US Treasury yields hit their highest level since the 2008 financial crisis.
Most just assume rising rates are bad. However, every price change is ambiguous and can lead to the wrong conclusions. Economist (and blogger) Scott Sumner has called this fallacy “reasoning from a price change”. In his book, The Money Illusion, he uses oil as an example, saying a high price doesn’t tell you anything about consumption patterns because “it all depends on the cause of the price increases”.
The same logic applies to interest rates. So, the Squeeze talked to Sumner and he laid out a framework for understanding interest rate changes. The first step is to look at the expected nominal GDP growth, which is the combination of real GDP growth and inflation. Therefore, it can be increased by either producing more stuff or printing more money. This makes sense intuitively. If borrowers expect nominal growth to be high in the future, then they will be happy to borrow more now, believing they will easily be able to pay it off. This increased demand allows lenders to charge higher interest.