Post‑Pandemic Interest Rates: Lower for Longer

U.S. Treasury yields plunged to new all-time lows after the onset of the coronavirus pandemic, reflecting a flight toward safety by investors, the prospect of a very deep recession, and large-scale purchases of Treasuries by the Federal Reserve. How long-lasting will this environment of super-low interest rates be?

Some observers argue that once the pandemic passes, record-wide fiscal deficits, concerns about debt sustainability, and higher inflation will push nominal and real interest rates back up to, and potentially even above, pre-pandemic levels. Others believe that a combination of a larger private sector saving glut and implicit or explicit nominal yield curve control by central banks will keep interest rates low long after the pandemic has passed.

History offers evidence for even-lower-for-longer outlook

Both sides make good arguments, but only one can eventually be right. As already indicated in our recent Cyclical Outlook,From Hurting to Healing,” we believe that we have entered a “New Neutral 2.0” environment of even lower interest rates for longer. The history of pandemics and interest rates over the past seven centuries; of U.S. policy, inflation, and interest rates in the post-war 1945–1951 episode; and the experience following past recessions all provide evidence supporting this thesis.

Starting with the history of pandemics, in a recent working paper published by the San Francisco Federal Reserve Bank, Òscar Jordà, Sanjay Singh, and former PIMCO senior advisor Alan Taylor studied the path of real interest rates following 15 major pandemics since the 14th century that each cost more than 100,000 lives. The authors conclude that these pandemics had long-lasting economic effects, lowering the real rate of interest for decades after the end of each pandemic (see Figure 1, drawn from their paper).

Figure 1 displays the response of the natural real rate of interest in Europe to a pandemic, 1 to 40 years into the future. Following a pandemic, the natural rate of interest declines for decades thereafter, reaching its nadir about 20 years later, with the natural rate about 150 basis points (1.5%) lower than had the pandemic not taken place. At about 40 years later, the natural rate returns to the level it would be expected to have had the pandemic not taken place.