As the presidential elections took centre stage, an important market dynamic played out: the overall term structure for US interest rates steadily rose.
It’s a consequential measure. Negative real rates benefited diversified portfolios in the years leading up to the last tightening cycle. As central banks hiked in 2022, many investors were wrongfooted by thinking that positive 10-year real rates would weigh heavily on large-cap equity profits. But as rates failed to exceed realised inflation, companies that captured rising prices became extremely profitable. Now, with real rates trending upward again, could this scenario return? With 2025 coming into view, Simply put assesses the outlook.
The real-rate sequence
Real rates can be calculated in many ways. An economist might focus on 10-year market real rates, calculated as the difference between 10-year nominal rates and either breakevens or inflation swaps of the same maturity. Analysts might look at the difference between nominal rates and realised inflation. In the latter case, since realised inflation typically covers a one-year period, it makes sense to look at nominal rates of a shorter maturity for better consistency.
Figure 1 maps the behaviour of these two measures on a quarterly basis since March 2018, with two-year nominal rates used to calculate the difference between nominal rates and realised inflation. Even though the short- and long-term real rates are correlated, they don't follow each other systematically, which makes this analysis interesting. Three key phases can be observed:
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During 2020 and 2021, both short- and long-term real rates remained broadly negative. This helped the economy weather the pandemic and its consequences, minimising the risks of a prolonged recession
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| 2 |
Throughout 2022, short rates remained negative while long rates turned positive. In this period, inflation receded more slowly than expected and remained higher than short rates
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| 3 |
From 2023 to 2024, both short- and long-term real rates turned positive. Nominal rates remained elevated while inflation receded below their level.
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As we explain below, the sequence of these phases historically impacts corporate profits and market performance.
FIG 1. Relative behaviour of US 2-year and 10-year real rates1
Watch out for the double positives
From 2022 until H1 2024, the Federal Reserve (Fed) determined to suppress inflation. However, since August it has shifted its attention to supporting the labour market and its recent rate cuts cement this change in focus from the nominal to real economy. Such concerns about growth are well-founded: since while the US economy is doing well today, we shouldn't lose sight of the fact that both short- and long-term real rates are now positive.
Figure 2 shows profit growth rates and US stock performance as a function of the combination of short- and longer-term real rates over the period from 1962-2024. As you can see, periods of generally negative real rates benefit corporate earnings and market valuations, but periods of generally positive real rates typically have the opposite effect. The underlying dynamic that surprised investors in 2023 can be seen in the charts: when short-term real rates are negative but long-term real rates are not, profits and valuations tend to increase more in the following year than when both short and long rates are positive.
Clearly, when inflation exceeded interest rates, it enabled profits and valuations to escape their corrosive effect. However, with inflation declining, this is no longer the case. As a result, monetary policy is probably more deflationary today than it was during 2022 and 2023. Fed rate cuts are now necessary to bring the US economy closer to a situation in which short rates are negative and long rates are positive in order to maximise the chances of a soft landing.
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FIG 2. One-year forward profit growth and stock performance as a function of 2-year and 10-year real rates2
What this means for All Roads
While economic conditions over the past two months have clearly shown signs of improvement, the total market exposures of our multi-asset strategies have not exceeded their 2012-2024 average. Trends in equity and credit markets remain firm, but sentiment is still downbeat. Given these mixed signals, we favour a slightly lower markets exposure with a balanced allocation between hedging and cyclical assets.
Simply put, the entire real-rate term structure is now positive. Investors should consider how this could influence corporate profits and markets throughout 2025.
To learn more about our All Roads multi-asset strategy, click here.
Macro/nowcasting corner
The most recent evolution of our proprietary nowcasting indicators for global growth, global inflation surprises, and global monetary policy surprises are designed to track the recent progression of macroeconomic factors driving the markets.
Our nowcasting indicators currently show:
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Growth continues to trend upward, albeit at a slower pace, with the proportion of improving data observed declining from 60% to 53%
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The global economy remains in a zone characterised by positive and gradually increasing inflationary pressures
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Central-bank monetary policy can generally be expected to favour rate reductions.
World growth nowcaster: long-term (left) and recent evolution (right)
World inflation nowcaster: long-term (left) and recent evolution (right)
World monetary policy nowcaster: long-term (left) and recent evolution (right)
Reading note: LOIM’s nowcasting indicator gather economic indicators in a point-in-time manner in order to measure the likelihood of a given macro risk – growth, inflation surprises and monetary policy surprises. The nowcaster varies between 0% (low growth, low inflation surprises and dovish monetary policy) and 100% (high growth, high inflation surprises and hawkish monetary policy).
