AOR Update: Are Higher Rates a "Real" Problem?

Higher Treasury yields are unlikely to pose a lasting threat to equities because they mainly reflect stronger real growth and monetary-policy repricing rather than an inflation, fiscal or credibility shock.

• The S&P 500 was up 12.3% through August; when gains exceeded 10% through August, the index rose from September to December in 25 of 28 cases, with an average remainder-of-year return of 5.3% versus 3.6% for all periods since 1950.
• The 10-year Treasury yield had risen more than 80 bps from its late-February low to nearly 5%, but the increase since then came mainly from a 50-bps rise in real yields, compared with 15 bps for inflation expectations and 17 bps for the term premium.
• Treasury CDS spreads were essentially unchanged from late February, investment-grade spreads were near cycle tights, and the term premium was around 80 bps, offering limited evidence of a fiscal or credibility shock.
• Nominal GDP is growing at roughly 6% while the 10-year Treasury yield is around 4.75%, a relationship comparable to the 2001–2007 expansion, when nominal GDP growth was close to 6% and the 10-year yield averaged 4.5%.
• Second-quarter S&P 500 EPS rose 52% year over year, while the index gained less than 3% during earnings season; the ClearBridge U.S. Recession Dashboard remained firmly green and expansionary in August.
• Although futures priced a 65% probability of a Fed rate hike in September, moderating consumption, easing real-income pressures or disinflation could lower long-term yields, while AI-driven productivity gains could support growth without reigniting inflation.

Takeaway: Investors should view higher rates as economic normalization rather than a lasting equity shock, while recognizing that a pause or decline in yields would provide the strongest catalyst for another advance in risk assets.