What are real yields?

Real yields are interest rates that have been adjusted for inflation, representing the true purchasing-power return an investor earns on a bond. The most widely tracked real yields come from TIPS (Treasury Inflation-Protected Securities), whose principal adjusts with the Consumer Price Index, isolating the real component of Treasury returns.

The relationship is straightforward: the nominal Treasury yield equals the real yield plus expected inflation (the breakeven inflation rate). For example, if the 10-year Treasury yields 4.5% and the 10-year TIPS yields 2.0%, the market-implied 10-year inflation expectation (breakeven) is 2.5%. This decomposition is one of the most important frameworks in fixed-income analysis.

Real yields are the single most important driver of several major asset classes. Gold and bitcoin have strong inverse correlations with real yields because they pay no income. When real yields are high, the opportunity cost of holding non-yielding assets rises, and gold and crypto face headwinds. When real yields are negative (as they were for much of 2020-2021), there is no cost to holding alternatives, and precious metals and crypto tend to rally.

For equity markets, real yields function as the discount rate for future cash flows. Growth stocks, whose value depends on earnings far in the future, are particularly sensitive to changes in real yields. The sharp selloff in growth and technology stocks during 2022 was driven primarily by the rapid rise in real yields from deeply negative to over 2%.

The Fed closely monitors real yields because they represent the true tightness of financial conditions. A high nominal rate paired with high inflation expectations may not actually be restrictive, while a moderate nominal rate with low inflation expectations can constitute significant real tightening. Understanding real yields provides a clearer picture of monetary policy stance than nominal rates alone.