Skip to main content
Weekly Market Update

Real Rates: A Slowdown or Growth Signal?

Discover how real rates influence economic growth and inflation, with insights on the US 10-year real rates and S&P 500 EPS changes.

Head of North American Investment Strategy & Research

Insight of the Week

Real rates are the portion of nominal rates that remain after removing inflation expectations. At times, higher real rates can have different meanings. From a negative angle, higher real rates add pressure on the economy as borrowing costs are restrictive. Conversely, a Federal Reserve that’s willing to raise policy rates can signal that economic growth is healthy and can absorb a higher cost of capital.

Earnings vs Real Rates

In the above chart, we show the relationship of US 10-year real rates versus the 1-year change in EPS for the S&P 500. Prior to the past few years, there was a decent positive relationship between the two. The interpretations is that as corporate profits were increasing and healthy, they could handle higher real rates, symbolic of a growing environment. Enter hot inflation in 2022 and this relationship has now broken down as the Fed uses high real rates as a weapon to purposely slow down the economy, pulling inflation down.

Currently, real rates remain close to highs and are a step function higher than anything seen over the past 10+ years. We believe inflation will continue to normalize, so our concern turns to the economic growth. Real rates, at this level, is restrictive and will be a headwind on earnings. Policy rate decisions act on a lag so waiting to cut until the first sign of trouble could be a mistake. Currently, the market is pricing in a first rate cut in November. However, we continue to prefer a first rate cut sometime this summer.

More Weekly Market Updates