For over a decade the real rate of interest has been negative. This was a great period to borrow money and leverage investments. This period was not normal regardless of the length of time. The rate world is normalizing and that means the real rate will be positive and closer to the long-term growth in the economy.
Nevertheless, there is still room for debate on what is the current real rate of interest. A simple version is the nominal rate minus the inflation rate, but that may not reflect expected inflation over a specific horizon. This simple measure real rates are just turning positive. If we look at nominal rates minus breakeven inflation rates, the real rates have been but getting more positive. The story is still the same; real rates are moving higher and this matters.
Higher real rates increase the true cost of capital Levered firms will lose. New investment project will be placed on hold. The housing market will further tighten. Economic activity will slow although the extent of this slowing is unclear. Stock market valuations will decline.
Some are calling for a market crash which is a sudden revaluation based on a significant change in expectations. Whether this is likely is up for debate, but the probability of a large down event will increase with an increase in real rates. The TDEX tail risk index is moving higher but still below the maximum levels set earlier in the year.
The core message is that real rate normalization will have spillover to the rest of the economy and asset prices. Fixed income repricing cannot be looked at in isolation.
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