Macquarie: Have investors exited the low interest rate world?

According to the Macquarie report, the era of low volatility has ended, and investors are facing a world with higher volatility in inflation outcomes, where the consensus on "appropriate" social, political, and economic norms has collapsed. The bank believes that the future will not belong to sustained deflation or sustained high inflation, but rather a coexistence of both: a world with high real interest rate volatility, influenced by exogenous shocks that both central banks and investors cannot predict or estimate. For some time to come, investors will still be in a low-interest-rate world, with rates of 2% and 5% both possible.

Although G5 inflation has returned to pre-COVID-19 trajectories (-2%), the average masks the increasingly severe asynchrony.

Aside from some fluctuations in China, inflation in the United States, the United Kingdom, the Eurozone, and Japan has maintained astonishing consistency over the past thirty years: a deflationary trend from the 1990s to 2020, followed by a synchronized surge in 2021-2022 due to the global pandemic, and a similarly rapid decline in 2023-2024.

However, in the past six months, evidence of asynchrony has been accumulating, with deflation intensifying in the Eurozone while inflation remains high in the UK and Japan.

Despite the Federal Reserve achieving its target, the chaotic policies of "Trump 2.0" (such as tariffs, trade, and immigration policies) are threatening the stability of inflation in the United States.

Investors are faced with a world of higher volatility in inflation outcomes (and thus often asynchronous monetary policies), or a new equilibrium of sustained high inflation that could even lead to stagflation?

Whether referred to as "long-term stagnation" (growth cannot occur without stimulus) or the more technical term "declining real neutral interest rates," both generations of investors have grown up in a deflationary world driven by the fusion of technology and financialization. This era has favored the appreciation of most assets, especially those closest to the source of debt (such as financial and speculative assets) and digital capital. The decline in real interest rates (from 3-4% in the U.S. in the 1980s to 0.5-1%, and -50 to -100 basis points in the Eurozone and Japan) has left central banks with no choice but to stimulate the economy through interest rate cuts and liquidity injections.

However, the strong opposition in society to the resulting inequality and injustice, as well as the erosion of human value (i.e., the diminishing marginal utility of labor) and the depreciation of traditional capital, has created a harmful atmosphere.

Whether it is the rapid swings in non-traditional election results from right to left and back to right in countries like Poland, the U.S., and the U.K., cultural conflicts, destructive referendums like Brexit, social polarization, or the destruction of global norms, these are all symptoms of a "disease": **the consensus on "appropriate" social, political, and economic norms that dominated from the 1980s to the global financial crisis has collapsed **

The COVID-19 pandemic has exacerbated this anxiety, reigniting latent inflationary fluctuations.

If the Democrats win, or if China is committed to a strong pace of structural reforms, will the uncertainty be less pronounced? That is debatable.

But one thing has become clear: the era of low volatility is over. One unresolved question is how destructive these factors will be. Politics, geopolitics, climate, healthcare, and our responses through trade, fiscal, monetary, or military means.

We believe the future will not belong to sustained deflation or sustained high inflation, but rather a coexistence of both: a world of high real interest rate volatility, influenced by exogenous shocks that neither central banks nor investors can predict or estimate. Risk premiums and inflation are similarly affected.

However, in the long run, deflation will prove to be the stronger force, as the disintermediation of labor and capital will redefine the roles of both, unleashing a surge in productivity.

But this will take years, and in the meantime, investors will continue to argue, unable to reach any consensus beyond uncertainty: three major events have occurred in the past five years; be prepared for more events.

We have not yet exited the low interest rate world, and both 2% and 5% interest rates are possible.