![\"\"](\"https:\/\/substackcdn.com\/image\/fetch\/$s_!7Kei!,f_auto,q_auto:good,fl_progressive:steep\/https%3A%2F%2Fsubstack-post-media.s3.amazonaws.com%2Fpublic%2Fimages%2Fc89f54f8-c06f-4944-8068-265c0fc09f83_801x730.png\")
<\/a><\/p>\nThank you for subscribing to my posts. If you\u2019re not yet a paying subscriber, please consider becoming one. That\u2019ll allow you to DM me with questions and comments. I plan to move my posts behind a paywall in coming months. Subscribing now locks you in at a low rate. Thank you so much for your support and feedback!<\/p>\n
At some point, there\u2019ll be a peace deal and the fighting will stop. Some time after that, tanker traffic through the Strait of Hormuz will normalize and oil prices will revert to their pre-war levels. What won\u2019t be headed back to the status quo ex ante is long-term interest rates, which have been on an upward trend since the global debt binge during COVID and have taken another step higher since the war began in February.<\/p>\n
Long-term interest rates consist of two things: (i) an extrapolation of monetary policy over the relevant horizon; and (ii) risk premia to compensate buyers for the risks they face by holding long-term government debt. The latter will rise if markets worry fiscal policy is irretrievably out of control. High long-term yields are insurance against the risk that governments inflate away public debt by printing money.<\/p>\n
Markets can be forgiven for worrying about this for three reasons. First, fiscal deficits reached completely unprecedented levels during the pandemic. Second, deficits stayed far wider in the years since COVID than before the pandemic, so something\u2019s become unmoored. Third, this isn\u2019t just a US problem. It\u2019s true for much of the G10, so lots of debt from all over the place is having to be absorbed by markets. No wonder longer-term yields are rising.<\/p>\n
The war only makes all this worse. It\u2019s deepened the rift between the US and Europe, so – if the Europeans didn\u2019t already have plenty of reasons to boost defense spending – they certainly have one now. It\u2019s also increased geopolitical uncertainty more broadly. Who\u2019s to say Russia won\u2019t test the fraying NATO alliance with some kind of incursion in the Baltics? Why wouldn\u2019t China be even more aggressive in its spere of influence? There\u2019s potential for lots of unintended consequences, all of which boil down to wider deficits and more debt.<\/p>\n