The bond market has become the central story for investors. The remarkable development over the past several weeks is not rising inflation expectations but rising real interest rates. Real rates have increased roughly 40 basis points in just three weeks, one of the sharpest moves I can remember over such a short period. Meanwhile, longer-term inflation expectations have actually edged slightly lower. This is a market repricing the strength of the real economy, not simply another inflation scare.
The growth numbers continue to surprise on the upside. Current GDP estimates range from roughly 3.3% at the low end to around 5% from the Atlanta Fed, while initial jobless claims have again come in below 200,000. That is simply not an economy showing much evidence that monetary policy has become restrictive enough. The market is increasingly questioning whether one additional Fed hike will be sufficient. If the incoming inflation and employment data remain this strong, the Fed will have to seriously consider a 25-basis-point increase in October followed by another move by year-end.
The most striking manifestation of this repricing is in the TIPS market. The 10-year real yield has approached 2.8%, a level we have not regularly seen in many years. That matters enormously for equities. A 20-times earnings multiple represents roughly a 5% earnings yield, so a real Treasury yield approaching 3% begins to meaningfully narrow the advantage stocks have enjoyed over bonds. It does not eliminate the equity premium, but it makes the competition much more serious.
Yet stocks have held up remarkably well, and there is a good reason. A stronger economy does not merely increase discount rates; it also increases earnings. Equities participate in nominal economic growth and provide protection from inflation, while fixed-rate bonds do not. That is why the stock market has absorbed this extraordinary rise in real rates considerably better than one might normally expect. The battle going forward is very clear: stronger earnings versus higher discount rates.
See more: Has the Bond Market Already Done the Fed's Job?
I will again be watching the money supply particularly closely. Weekly bank deposits showed a substantial increase in the latest data, and the next monthly M2 release this week will tell us whether the acceleration we saw previously is continuing. If money growth remains strong at the same time that employment and real GDP are accelerating, the Fed will have even less room to remain patient.
Higher rates also complicate the case for the small-cap and value rotation that many investors have expected from a stronger economy. Cyclically sensitive companies should benefit from better growth, but smaller companies are also much more dependent on short-term financing. Fed-funds expectations for mid-2027 have moved almost 100 basis points higher, while mortgage rates are again above 7%. Housing will remain restrained if those rates persist, and highly leveraged companies will feel that financing burden directly.
There is also a fascinating new force emerging from artificial intelligence. The initial reaction to Meta's new AI agent highlights a potentially much broader economic development. Companies in banking, telecommunications, insurance and other industries have long benefited from customer inertia. Consumers frequently stay with an inferior rate or service because switching simply is not worth the effort. An AI agent capable of comparison shopping, negotiating and switching providers changes that equation.
I wrote more than 25 years ago that the internet could intensify price competition by making comparison shopping dramatically easier. The results were mixed because consumers still had to take action themselves. AI agents potentially remove that final friction. If they begin negotiating phone bills, moving deposits toward higher-yielding accounts or routinely finding cheaper alternatives, they could attack what might be called inertial monopolies. That could ultimately be an important competitive, and disinflationary, force across the economy.
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Past performance is not indicative of future results. You cannot invest in an index. Professor Jeremy Siegel is a Senior Economist to WisdomTree, Inc. and WisdomTree Asset Management, Inc. This material contains the current research and opinions of Professor Siegel, which are subject to change, and should not be considered or interpreted as a recommendation to participate in any particular trading strategy, or deemed to be an offer or sale of any investment product and it should not be relied on as such. The user of this information assumes the entire risk of any use made of the information provided herein. Unless expressly stated otherwise the opinions, interpretations or findings expressed herein do not necessarily represent the views of WisdomTree or any of its affiliates.
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