Higher real rates globally are boosting the outlook for large cap equities

Recent central bank decisions, particularly those of the Federal Reserve (Fed), have fuelled market fluctuations and significantly contributed to the volatility of global economic projections. And by influencing investor expectations, monetary policy directly shapes the trajectory of interest rates – especially real rates.

This evolution is crucial, as real rates determine the cost of capital and, consequently, global economic constraints. So, where do we stand in terms of real rate expectations, and what are the implications for markets? Our final instalment of Simply put for 2025 examines the repercussions of real-rate variations throughout the global economy and for investors’ perspectives. This topic circles back to September 2021 and the first issue of Simply put, which assessed real-rate trajectories.

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Positive real rates across the board

The real-rate term structure evolves along two main dimensions: the overall level of rates, which fluctuates between positive and negative territory, and the steepness of its slope, which alternately steepens and flattens. Figure 1 illustrates these structural fluctuations in the US over an extended period, specifically focusing on instantaneous real rates across different maturities. These instantaneous forward real rates provide valuable insights into market expectations about future real-rate trajectories – a critical element for interpreting investor sentiment.

The graphs highlight three distinct configurations:

• Periods when real rates across different maturities align in positive territory, as observed in 2006, 2017, and 2022
• Phases where the curve maintains an upward slope but with negative short-term rates, typically following major economic shocks – such as those in 2008 and 2020
• The current configuration – representing a transitional period between these two states – characterised by a progressive curve restructuring as short-term rates decline more rapidly than long-term rates.

Today, the term structure is both upward sloping and positive, conveying a significant message: markets anticipate positive real rates for both present and future periods. This configuration implicitly suggests a less accommodative long-term stance from the Fed. Moreover, it is far from certain that this trend is exclusive to the US.

FIG 1. US instantaneous forward real rates¹

Not just a US phenomenon

Figure 2 presents similar calculations for European and Japanese yield curves. Our observation is globally the same – albeit with a nuance for Japan, where the term structure of real rates has become upward-sloping once again. While it is positive in Europe, it remains negative in Japan for maturities less than 10 years.

Here too, a strong signal emerges: long-term real rates for these economies are forecast to be in constraining territory. This applies, more or less, to all G10 economies. So it’s official: the party of negative real rates is over and its end will likely carry several investment implications – starting with small and mid-caps.

FIG 2. Recent evolution of real rates in the Eurozone and Japan²

Small caps at the fore

Historically, small-cap stocks often outperform larger companies in the long term³, but in an environment where real rates are high and the yield curve steep, this premium tends to weaken. Figure 3 illustrates this point in two ways:

1. Since 2004, the sweet spot for US small caps (presented here in long/short terms) occurs when the term structure of forwards is clearly upward-sloping but at low levels (typically below 1%). The current instance of high real rates with a steep term structure only benefits small and mid-caps marginally without necessarily hurting them significantly; it's certainly not the environment in which they shine
    
2. When examining the cross-section of real rates in the US, Japan, Switzerland and Europe from 2021 to 2025, we observe a similar phenomenon, this time based on long-only performance. The data shows that in countries where real rates have remained low (like Japan or Switzerland), small caps have shown greater resilience against large caps. Conversely, in the US or Europe, where real rates are higher, large caps dominate.

As we prepare for 2026, we must keep in mind that this new term structure of real rates may influence the concentration of market performance, continuing the strong run of large-cap stocks. An unexpected decline in real yields could reshuffle this situation, supporting diversification over concentration.

FIG 3. Performance of small caps based on real rates in the US (2004-2025) and by country (2021-2025)⁴

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The implications for multi-asset investors

This real rate situation is particularly relevant for our strategies as we prepare for the year ahead. High real rates over the next decade should help renew interest in bonds, which have been somewhat neglected in recent years. High real rates can also signal significant equity returns, as illustrated above, while creating the risk of a slowdown that makes the equity/bond combination even more attractive. Real rates also represent an opportunity in themselves, but given their ‘macro’ effects on financial markets, we should not underestimate the potential risks of this scenario.

Simply put, the market anticipates positive real rates over the very long term, an element to keep in mind as we approach 2026.

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:

• Our growth signal strengthened in China, while other regions remained stable or displayed a slight decline. The global nowcaster edged higher, supported by improving data 
• In China, our inflation signal also increased, while declining in the Eurozone and the US, where it approached the 50% threshold
• Our monetary policy signal has fallen, particularly in the US. However, the China nowcaster rose, reaching the 50% level.

World growth 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% (the high growth, high inflation surprises and hawkish monetary policy).