A lot of the time, when talking about interest rates, we talk in nominal terms. Treasury yields, mortgage rates, whatever—the stated, headline rate is the nominal rate. These matter, because they are what borrowers actually pay and lenders actually receive. It’s the sticker price. But what is the real cost? What is the actual rate after taking inflation into account? That’s what we call the “real” rate—and it’s the focus of this week’s indicator.
Specifically, this week’s indicator looks at the real Fed Funds rate—the rate the Fed sets, adjusted for inflation. In the middle clip on the chart above, this is shown as the orange line, smoothed over 3 months, and then compared to its historical average using standard deviation bands. The bottom panel converts this into a Z-score, so we can more easily see how tight or loose policy is relative to the past six years (72 months).
As the performance box at the bottom reveals, historically (going back to 1966), the S&P 500 (green line, top clip) has delivered its strongest monthly returns when real rates are below 1 standard deviation from its average—i.e., monetary policy is economically loose. However, when policy is restrictive, meaning real rates are over 1 standard deviation from the mean, stock returns drop quite a bit.
Why does it work like this? Because real rates shape risk-taking behavior. When real rates are low, cash is less attractive to hold, and borrowing is easier, so investors tend to favor riskier endeavors, like stocks. But when real rates move above trend, financial conditions tighten, and investors are less willing to risk their capital on riskier investments.
At the end of the day, this indicator sits squarely in the economic category, but it’s not meant to be a short-term timing tool. Instead, it helps frame the broader backdrop. It gives context for why markets may feel supported or constrained beneath the surface, even when headlines focus on nominal rates alone. In that sense, it’s less about predicting the next move and more about understanding the environment investors are operating in today.
This is intended for informational purposes only and should not be used as the primary basis for an investment decision. Consult an advisor for your personal situation.
Indices mentioned are unmanaged, do not incur fees, and cannot be invested into directly.
Past performance does not guarantee future results.
The S&P 500 Index, or Standard & Poor’s 500 Index, is a market-capitalization-weighted index of 500 leading publicly traded companies in the U.S.