I would like to know why interest rates on short-term loans are higher than long-term ones. I’m 66 and I don’t remember seeing this. Are we expecting a recession or are we expecting rates to come down soon?
R.Bilodeau
To answer this question, The Press called on Daren King, economist and financial analyst in the Economics and Strategy Department at National Bank Financial Markets in Montreal.
From the outset, Daren King recalls that “the yield curve is not usually inverted, with short-term rates lower than long-term rates”.
For what ? The basic explanation derives from the functioning of the market for credit and financing products.
“Essentially, when a lender lends money to someone or a business for a short term, the risk of default is usually less risky than when lending for a ten-year period. says Mr. King.
“That’s why lenders usually charge a higher interest rate on a ten-year loan than on a short-term one-year loan. »
However, observes Daren King following the example of the reader of The Press“we are now in an unusual situation where the yield curve is inverted, that is to say that short-term interest rates exceed long-term rates”.
An unusual situation, certainly, but not unprecedented, specifies the economist of the National Bank.
“It has happened a few times in recent decades, contrary to your reader’s observation. Among other things, we saw an episode of an inversion of the yield curve just before the pandemic, at the end of 2019, recalls Daren King.
“Previously, it happened just before the financial crisis in 2008 and the recession that followed. It also happened in the early 2000s after the bursting of the techno bubble in the financial markets and its negative impact on the economy. »
Why do these episodes occur?
What we generally observe is that when the economic outlook is getting darker, there is an inversion of the interest rate curve in the financial markets.
Daren King, Economist and Financial Analyst
“Besides, when we prepare economic forecasting models, we use the interest rate curve among the indicators that can help us see whether the economy is going into recession or not. »
In this context, does the recent inversion of the yield curve herald a coming recession?
Daren King points out that this time around, the inversion of the yield curve is mainly the result of recent decisions by the Bank of Canada to raise its key rate sharply, which has pushed short-term interest rates above long-term rates.
“The yield curve has become inverted after a period of historically rapid rate hikes. In just 15 months, the central bank’s policy rate rose from 0.25% in March 2022 to 4.75% in mid-June, King said.
“That’s what makes financial markets think that interest rates are getting too tight, and that they could push the economy into recession. »
That said, at National Bank Financial Markets, what is the prognosis for the coming months?
“In the current context, it becomes certain and certain that a slowdown in the economy is preparing, but without necessarily leading to a real recession, replies Daren King.
“Also, as this slowdown goes on, it will become more and more likely that interest rates have bottomed out and are starting to come down again. »
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