Long-term rates are not the primary problem, while the Federal Reserve is expanding the money supply too quickly.
For equities, that distinction matters. Higher rates are usually a valuation headwind, but abundant liquidity can support risk appetite, credit availability and asset prices. Banks will want to lend at higher rates to those that need it the most.
Conversely, easy money does not guarantee rising stocks if inflation pushes real yields higher or earnings deteriorate.
2. Core transmission channels: The textbooks tend to teach us that:
- Discount rates: Higher real yields reduce the present value of future earnings, particularly for long-duration growth stocks.
- Growth: Tighter policy eventually raises financing costs and weakens demand, pressuring earnings.
- Financial conditions: Bank lending, credit spreads and financing availability determine how aggressively monetary policy reaches the real economy.
- Liquidity: Money and credit growth influence the capacity and willingness of investors to hold risk assets. Liquidity can cushion valuation pressure, but cannot eliminate it.
3. Key nuances and regime dependence: Each time is different… remember we can’t predict other participants future actions with great accuracy.
Three distinctions matter: What make this case too unique for a simple model:
- Policy rates versus long-term yields: The Fed controls short-term policy rates directly, not the 10-year Treasury yield. Long yields also reflect inflation expectations, growth, term premiums and Treasury supply.
- Liquidity versus solvency: Ample liquidity can support asset prices, but it cannot rescue structurally weak earnings or unsustainable balance sheets indefinitely.
- Nominal versus real rates: Rising nominal yields are less damaging when inflation expectations rise proportionally than when real yields increase sharply.
The critical question is whether money and credit conditions are supporting risk-taking or whether rising real yields are tightening the effective cost of capital.
4. Practical implication for positioning: What I am considering
- Liquidity expanding, earnings resilient: Maintain selective equity exposure, particularly in quality businesses with strong cash generation.
- Real yields rising, liquidity tightening: Reduce expensive, long-duration exposure and leverage.
- Credit spreads widening, earnings revisions weakening: Prioritize balance-sheet strength and capital preservation.
In summary:
Do not trade the policy rate in isolation. Track real yields, credit creation, bank lending, liquidity conditions and earnings revisions together. Stocks respond to the combined price of capital and availability of capital … not just the Fed’s headline decision.
Best, Mario
