bahrainthismonth.com | NOVEMBER 2026 OPINION 115 End of Cheap Money? Dr. Jarmo Kotilaine is a seasoned development economist with 30 years’ experience across academia, consultancy, banking and government. This column is written in his personal and independent capacity. The recent volatility in global bond markets highlights an inherent paradox in monetary policy. The 21st century has seen an unrelenting sequence of shocks, from the dot-com bubble and global financial crisis to COVID-19 and conflicts in Eastern Europe and the Middle East. Monetary policy has played a major role in restoring stability. Central banks have lowered interest rates and purchased government and other debt, partly because of the political challenges of countercyclical fiscal policy and an enduring addiction to leverage. Yet by reducing the cost of capital, monetary policy has increased the appetite for borrowing, magnifying vulnerability to rate rises. The sustainability of this “monetary policy magic” has repeatedly come into question. After COVID-19, the combination of loose economic policies and supply chain disruptions amid a robust recovery created an inflationary impulse not seen in decades. Central banks were forced to tighten policy, facing a chorus of accusations that they had done too little, too late. Debt and Rising Yields This year has brought a sense of déjà vu. Just as waning post-COVID inflation was expected to allow monetary easing, central banks face fresh pressures. Energy market disruptions have pushed up inflation, while investors are increasingly anxious about government debt, especially in advanced economies. The US budget deficit for the fiscal year ending September 30 reached nearly $2trn, its highest level since 2021 and up 12 percent on the previous year. The deficit is expected to exceed 6 percent of GDP, compared with 5.8 percent in FY2025. The US is pursuing unusually procyclical fiscal policy amid a prolonged expansion, partly because of legal disputes over last year’s tariffs. With public debt now equal to GDP, neither major party appears interested in deficit reduction, even as interest costs consume a fifth of tax revenue. The US is hardly alone: gross public debt across advanced economies is close to 110 percent of GDP, up from around 70 percent at the start of the millennium. Under these circumstances, markets find it easier to envisage continued deterioration in fiscal metrics than meaningful corrective action. Such concerns recently pushed the yield on US 10-year Treasuries to a 24-year high. The median yield on wealthy countries’ 10-year sovereign bonds exceeds 4 percent, roughly five times its 2015–2021 average. The so-called term premium has also risen, prompting governments to reduce costly long-term borrowing while taking on earlier refinancing risks. A Structural Shift We live in an uncertain world. An apparently emerging trend can quickly become yesterday’s news as political winds change direction. We have heard repeated warnings about the end of cheap money before, only to see the apparent emergency pass. However, there are reasons to believe this time may be different. Most advanced economies have experienced a steady slowdown in growth, often exacerbated by challenging demographic trends. This strengthens the structural drivers of government spending, particularly healthcare and pension costs, while revenue growth struggles to keep pace. In many cases, the fiscal adjustment now required to restore sustainability approaches a daunting 5 percent of GDP. Many expect impressive technological advances eventually to deliver substantial productivity gains and a corresponding recovery in growth, but doubts remain. The extremely costly AI buildout faces concerns about the timing and scale of returns, alongside potential security risks. Given the scale of the boom, even a temporary market correction could be disruptive, although it might also relieve pressure on government bonds. Although economic forecasts have been upended with growing frequency in recent years, market analysts increasingly anticipate higher interest rates. An early October Wall Street Journal survey found that respondents did not consider the recent rise in long-term yields temporary. They expected the US 10-year yield to end 2026 at 5.1 percent and reach 4.78 percent at the end of 2027, up from July’s projection of 4.26 percent. The Federal Reserve is seen as lagging in its fight against inflation, with the federal funds rate expected to exceed 4 percent this year and remain there throughout 2027. Resolving ongoing military conflicts could ease supply-side inflation, but interest rate concerns are increasingly structural, linked to persistent deficits and demand for capital, including for AI. In February, the Congressional Budget Office projected that the 10-year Treasury yield would not exceed 4.3 percent for the rest of the decade. That now seems optimistic. The Cost of Higher Rates Higher interest rates will affect the financial system in multiple ways, starting with holders of sovereign debt. US banks’ unrealised losses at the end of June totalled $327bn, largely reflecting declining values of bonds purchased before rates began climbing in 2022. Investors will also reassess their asset allocations. Higher rates tend to favour savers over debtors, putting particular pressure on longer-term loans such as mortgages. They also offer more attractive returns for less risk, forcing investors to reassess how they allocate capital. Real investments will face greater scrutiny because returns must compensate for the higher cost of leverage. A growing premium on quality is also likely to go hand in hand with a reduction in overall capital deployment. There is another possibility. Political and structural obstacles make serious debt reduction difficult amid unprecedented leverage. Historically, inflation has provided another way of reducing high debt burdens, as happened in the 1970s. Even as major central banks remain formally committed to conservative inflation targets, US inflation, for instance, has remained above the Fed’s 2 percent target since March 2021. Some additional flexibility may indeed be called for, and even be desirable, but releasing the inflation genie from the bottle has never been a simple exercise.
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