Economics Update October 2026 - The rise in interest rates is structurally driven—a rapid reversal of the trend is unlikely

Long-term interest rates have risen sharply in a short period of time: The yield on 10-year U.S. Treasury bonds has risen by more than 160 basis points since March 1, while the yield on German government bonds has risen by about 120 basis points. This reflects a reassessment of interest rate levels by market participants in light of fundamentally changed economic conditions. This reassessment has been underway for several years now: By 2022 at the latest, it was clear that the long phase of falling interest rates—and the resulting very low interest rate environment—had come to an end.

Three factors play a key role in this reassessment process: First, inflation is once again a concern. In the first two decades of the 21st century, globalization ensured that inflation rarely rose above the 2 percent mark. As a result of geopolitical fragmentation, widespread deglobalization, and demographic trends, structurally higher inflation rates are to be expected.

Energy price shocks, such as those seen this year, are an additional factor driving inflation above the 2 percent mark and thereby putting pressure on central banks. The central banks themselves—and this is the second driving force behind the rise in interest rates—must consequently adjust their role and their policies. Particularly with regard to the U.S. Federal Reserve (Fed), there is considerable uncertainty regarding the nature and scope of this adjustment. It remains to be seen whether this uncertainty will be resolved when the working groups established by Fed Chairman Kevin Warsh present their findings at the end of the year.

The third factor is government debt. While this had already reached unsustainable levels in many cases even before 2022, However, fiscal stimulus programs in the wake of the COVID-19 pandemic and additional defense spending driven by geopolitical concerns have further exacerbated the problem. New theoretical approaches—some of which are more or less ideologically driven and attempt to justify that higher government spending and debt are unproblematic—have also played a role in this. Every additional basis point that finance ministers must offer on newly issued bonds to ensure they attract enough buyers further exacerbates the situation (and, incidentally, demonstrates that key tenets of Modern Monetary Theory are flawed).

In recent weeks, however, another factor has been largely responsible for the rise in interest rates: the fact that hyperscalers are increasingly financing their heavy investments with debt rather than from cash flow, as they did before, is intensifying competition for scarce capital. As is typical in market processes, this leads to higher prices—that is, rising interest rates.

A decline in interest rates is just as unlikely as a significant further increase

All of the factors mentioned will remain in effect for the time being. A fundamental shift toward falling interest rates is therefore not expected. However, the scope for further interest rate hikes is also likely to be limited: if the cost of scarce capital continues to rise, an increasing number of investment projects will become unprofitable. The hyperscalers will certainly not be the first to be affected. Their investments in AI infrastructure are linked to high profit expectations, and they would therefore continue to invest even if interest rates were to rise further. In the rest of the real economy, however, signs of a slowdown are likely to emerge if certain interest rate levels are exceeded. Lower demand for capital would cause its price to fall, but it would also have significantly negative effects on growth momentum. So far, there are hardly any signs that such a process has already begun. For the foreseeable future, however, this remains a realistic scenario that deserves attention.

Falling interest rates could also result from high productivity gains, such as those hoped for as a result of AI investments. This would lead to disinflationary trends and a further acceleration in growth momentum. In the longer term, this is entirely realistic. However, there are no signs so far that this scenario will materialize anytime soon.

A fundamentally changed fiscal policy aimed at sound public finances would, of course, also ease pressure on interest rates in the long run. However, it is not foreseeable that this will happen—neither in the U.S. nor in Europe. Just how difficult it is to set such a process in motion can be seen right now in France. As a “solution,” therefore, financial repression is on the table—that is, limiting interest rates through government measures, usually with the assistance of central banks.

For the time being, interest rates are likely to remain high, barring normal fluctuations. While the potential for a further increase is limited, a general downward trend reversal is equally unlikely—and if it were to occur, it would be accompanied by a general deterioration in the fundamental environment for the capital markets.