Interest rates could shoot up much faster than expected over the next 18 months, stunning markets and delivering a sharp shock to borrowers, credit ratings agency Fitch has warned.
The US Federal Reserve’s base rate could rise to 3.25pc by autumn next year, smashing through the 3pc mark at least a year before the average Fed policymaker’s forecast.
Fitch’s forecast includes four rate rises this year, double the pace of two which markets currently anticipate. “Our impression of the Fed is that it wants to get on with this, and the rationale for leaving rates lower for longer has disappeared,” said James McCormack, in charge of sovereign ratings at the agency.
“It will take something unexpected to interrupt the path of higher interest rates. We are not anticipating that, so we think rates are going to move higher than the market believes they will.”
Very low unemployment and the continued easing of financial conditions are likely to push the Fed in this direction, he said. “At some point … the risk of doing too little becomes greater than the risk of doing too much,” he added.
Fitch issues warnings to investors when risks arise which could threaten borrowers’ ability to repay loans. Their fears over a steep rise in rates could have significant implications for corporations and governments that are trying to raise more debt.
Mr McCormack’s warning comes after the World Bank said financial markets are the biggest risk to the global economy and that an unexpected rise in rates could cause turmoil in the years ahead.
Citigroup analysts also warned last week that tighter monetary policy could stun global markets.
Mr McCormack does not think this set of rate rises will hit the economy hard for now as the hikes to date have not fed through to substantially increased borrowing costs.
“It depends where market rates go and we have not really seen market rates respond,” he said, noting that US government 10-year bond yields remain low.
“That is what we will be watching, the response from longer-term interest rates. If and when we see 10-year yields move higher, then the economic consequences will be more significant.”
So far there are only hints of this taking place. Two-year government bond yields rose above 2pc on Friday for the first time since 2008 while 10-year yields have risen to 2.6pc.
This remains well below the level of borrowing costs in the decade before the financial crisis, however, when the US government typically paid between 4pc and 5pc to borrow for 10 years.
As the US market is traditionally seen as the global risk-free benchmark, other debts are priced against its yields.
This means that rising rates in the US market could push up borrowing costs across the rest of the world regardless of other central banks’ actions.