Higher for Longer 2.0

How beautiful the world was at the turn of the year! At that time, lower interest rates were still expected in the USA, they were hardly expected to rise in the Eurozone, and declining inflation was no longer an issue. But by the end of February, everything changed: The attack by Israel and the USA on Iran led to the closure of the Strait of Hormuz, oil prices surged drastically within a very short time, and as a result, all inflation forecasts from the beginning of the year could be thrown into the trash.

One must imagine Sisyphus as a central banker.

Central banks are like Sisyphus: Just before they reach the target rate of 2%, the stone starts rolling again, and the next inflation surge is just around the corner. For many, it is tempting to compare the current situation with the beginning of the Ukraine war. However, there are significant differences compared to February 2022: Inflation is considerably lower, but still above 2%, interest rates are higher, and bond yields as well. This applies to both the EUR and the USD. Inflation, interest rates, and bond yields are closely related but not directly proportional to each other.

In the Eurozone, the deposit rate stands at 2.00% (since June 2025). In the USA, the upper end of the Fed Funds Target Range is at 3.75% (Bloomberg, 15.5.2026). This keeps the interest rate differential between USD and EUR significant, which could tend to support the USD, provided the differential does not change drastically. In the long term, over several years, however, we expect a weaker USD due to purchasing power parity. Markets expect the interest rate differential to narrow by the end of the year. It is anticipated that the ECB will raise interest rates, while the American central bank will most likely keep them unchanged.

Inflation Surge 2.0

Until the end of the year, it will be crucial how persistent the inflation surge is. Will it spread through the entire consumer basket, including possible further effects on wages, or will we be spared this scenario? This time, unlike in 2022, central banks will act more quickly and decisively to prevent this from happening and to stop inflation expectations from rising further by year-end, which could cause additional inflationary pressure through second-round effects. They are thus resuming their Sisyphean task in the fight against inflation. It is important not to forget the difference between the FED and the ECB: Unlike the ECB, the American central bank also considers employment and will therefore not act as restrictively as the ECB might.

Bond yields have risen considerably since the outbreak of the war. German government bonds with a remaining maturity of 10 years yield over 3.15% (Bloomberg, 15.5.2026) — a level not seen since years of negative interest rates since 2011. In the USA, the level is even higher, with yields currently at 4.58% for these maturities (Bloomberg, 15.5.2026). However, these levels were temporarily higher in the USA in 2023, 2024, and 2025.

Our Investment Strategy

Even if the ECB and the FED do not raise interest rates significantly, yields can remain "high" or even rise further in the long term as long as inflation does not credibly fall toward 2%. Especially new issuances driven by further budget deficits due to infrastructure programs or defense investments can push yields higher through increased supply. In this regard, there seems to be no upper limit in the USA, where the government moves from one debt ceiling to the next. For this reason, we are currently very cautious regarding bond yields and have significantly reduced interest rate sensitivity in our portfolios.

What lessons can investors draw from this? Interest rate expectations have changed relatively quickly and very sustainably. Therefore, take the opportunity to speak with your private banker and review your portfolio. Perhaps one or another adjustment could be quite sensible for you.

This document is a marketing communication of Kathrein Privatbank Aktiengesellschaft within the meaning of the Austrian Securities Supervision Act 2018 and serves exclusively for informational purposes. This information aims to provide a general overview of current market data and Kathrein’s market opinion and does not constitute a direct or indirect recommendation for a specific investment strategy or financial analysis. Investments in securities are subject to price fluctuations due to market changes at any time. Data and representations relating to past performance do not allow reliable conclusions about future results. Despite careful research and recording, no liability or guarantee can be assumed for the accuracy of the data.