Higher Interest Costs Will Continue for Some Time, Study Says

You have heard the phrase “higher for longer” about interest costs. For how much longer, though? By one estimate, well into the next decade.

The common wisdom is that the Federal Reserve sets interest rates, and, indeed, the body’s federal funds rate is the key U.S. benchmark for other rates. But a broader force is at work, long known in economics as “the natural rate of interest,” also known as a neutral interest rate or R-star.

This “natural” rate is on the ascent and projected to remain high into the 2030s, according to research by the Bloomberg Economics unit. If that is accurate, overall interest charges, for everything from corporate bonds to credit card loans, will remain on the high side for some time, compared with the low cost of money people had enjoyed until last year.

Previously, the natural rate—which would keep the economy in balance at full employment (typically 95% or above)—was estimated in the vicinity of 1.7%, and now it is approaching about 2.7%, where the Bloomberg study predicted it will stay for years into the 2030s. This rate is a baseline, and longer-term bonds will yield at least a couple of percentage points above it.

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The Bloomberg economists noted that the natural rate is hard to place with precision because it is an agglomeration of numerous factors that range far beyond Fed actions. It is a theoretical estimate and depends on some factors that cannot be measured and others that move in opposite directions.

Current examples: rising inflation, higher levels of government borrowing, bigger climate change spending from private and public sources, retiring Baby Boomers drawing down their savings, and an explosion in technological advances, particularly artificial intelligence.

Different scholars have put these all together in different ways, but the Bloomberg estimates generally agreed with others in pointing toward higher-for-longer rates. The lack of more precise figures—such as the exact current rate—has spurred Fed Chair Jerome Powell to downplay the natural rate’s usefulness.

A Bloomberg summary (the study was not released by Bloomberg’s economics unit) explored the impact on the U.S. economy of a higher natural rate. For instance, Bloomberg indicated, the 10-year U.S. Treasury yield could settle around 4.5% to 5%, where it is now, or perhaps as high as 6%.

A long spell of higher rates would have both pluses and minuses, the Bloomberg study suggested. On the negative side, there will be many years ahead where more companies will be unprofitable due to higher borrowing costs, homeowners will have higher mortgage costs, the stock market will face headwinds as low rates vanish, and Washington will have a bigger interest payout, thus risking deeper deficits. On the positive side, bondholders will enjoy sweeter yields. Any impact on inflation, however, is not known.

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Tags: 10-Year Treasury, Artificial Intelligence, Baby Boomers, Bloomberg Economics, bondholders, Climate Change, corporate bonds, credit card loans, Federal Reserve, Inflation, Jerome Powell, natural interest rate, R-star, Stock Market

John Hughes bilked dozens of victims of nearly $300 million in a ‘brazen and sophisticated fraud’ and has already pleaded guilty to criminal charges.

The Securities and Exchange Commission has charged John Hughes, co-founder, president and chief compliance officer of Prophecy Asset Management LP, with orchestrating a “brazen and sophisticated” fraud over nearly seven years that concealed hundreds of millions of dollars in losses from investors.

The victims included domestic and foreign investors such as pension plans, family trusts, high-net-worth individuals and other institutional investors.

In a parallel action, the U.S. Attorney’s Office for the District of New Jersey charged Hughes with one count of conspiracy to commit securities fraud, to which Hughes has already pleaded guilty.

The SEC’s complaint specifies that Hughes and his associates at Prophecy Asset Management, which advised multiple hedge funds, collected more than $15 million in ill-gotten fees while misleading the funds’ investors, auditors and administrator about their trading practices, risk and performance.

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From 2014 through March 2020, Hughes and the firm raised more than $500 million for the investment funds, all the while misleading investors about the safety of the investments, according to the complaint. According to the SEC, Hughes conned investors into believing their investments were protected from losses by claiming they were diversified among dozens of sub-advisers who traded in liquid securities and posted cash collateral to offset any trading losses they incurred. However, in reality, Hughes and the firm “did not provide investors with stable, diversified, risk-managed, well-performing funds” and instead concentrated a “huge percentage” of the investment funds’ assets with a lone sub-adviser who “sustained massive losses unbeknownst to investors.”

According to the complaint, Hughes also caused the funds to invest in highly illiquid investments, which resulted in significant losses. The regulator also accused Hughes of trying to hide the losses by fabricating documents and engaging in a series of “sham” transactions “designed to give the false appearance that investments had performed profitably.”

After racking up losses of more than $350 million in funds that Prophecy Asset Management managed, Hughes and the firm suspended redemptions by investors indefinitely in 2020, according to the complaint.

“We allege that John Hughes committed a brazen and sophisticated fraud that deceived investors to keep Prophecy Asset Management and the funds afloat, despite massive undisclosed trading losses,” Nicholas Grippo, regional director of the SEC’s Philadelphia Regional Office, said in a statement. “As president and CCO, Hughes served in an important gatekeeping role and owed fiduciary duties to his clients. As alleged, he did not live up to those duties.”

The SEC’s complaint, also filed in U.S. District Court for the District of New Jersey, charges Hughes with violations of the antifraud provisions of federal securities laws and seeks a permanent injunction, disgorgement of ill-gotten gains plus interest, civil penalties and an officer and director bar. Hughes is scheduled to be sentenced on the criminal charges on March 21, 2024. Conspiracy to commit securities fraud carries a maximum penalty of five years in prison and a $250,000 fine.