Falling Real Yields Are Key to Understanding Today's Markets

For all the talk about how the Federal Reserve has finally decided to pick up the pace of interest-rate increases, the fact is that real rates -- or those after taking into account inflation -- are not only still negative, but getting even more negative.

Normally, that’s not such a bad thing if the goal of a central bank is to spur growth and the price of assets. But the problem now is that negative rates have weighed on the dollar, which is helping to push asset prices to or close to record highs. Although global economic growth is picking up, it’s nowhere near levels that would justify such valuations. If history is any lesson, then investors might want to study the 1970s, when the Fed responded to similar conditions by stepping up the pace of rate hikes in an effort to cause real rates to turn positive. The period from mid-1976 through March 1978 wasn’t a very good time for stocks and riskier assets in general.