From the surge in global stock markets and the resilience of gold to arbitrage opportunities in emerging markets, the underlying assumption for this year’s cross-asset trends is that “real interest rates will decline”—but is this really the case?
Overnight, US stocks retreated significantly, while long-term US Treasury yields continued to rise. Not only in the US, but bond yields in major economies such as Germany, Japan, and the UK have also been trending upward recently. Global capital is re-pricing for "higher interest rates and higher capital costs."
The issue is that this is actually inconsistent with the main narrative that the market has been trading on over the past few months. The current market consensus has always been: economic slowdown, falling inflation, and the Federal Reserve eventually cutting rates, thus real interest rates should gradually decline and risk assets can continue to benefit from a carry trade environment.
However, in reality, the bond market hasn't bought into this logic. According to Chasing Wind Trading Desk, on August 18, the Goldman Sachs team led by Vitali Meschoulam argued that what is truly determining market direction right now is the real yield.
Risk assets have actually priced in future easing in advance: stocks, credit bonds, EM carry trades, and gold are all pricing in a scenario where real yields will ultimately fall; yet the bond market continues to keep the 10-year US real yield at around 2.5%, not confirming this expectation.
In other words, the biggest contradiction in the market right now is:
The equity markets believe that rate cuts will be realized, while the bond market thinks long-term capital costs remain elevated.
If real yields do fall going forward, the logic behind the current rally in risk assets will be validated; but if real yields stay high, then stocks, credit bonds, and the entire carry trade could face repricing risk.
Goldman Sachs believes, ultimately, one side must "admit being wrong"—either bond yields fall or risk assets move lower.
Cross-Asset Correlation: Only One Bet Behind It All
On the surface, the strong performance of global assets this year comes from multiple reinforcing narratives:
- CPI data from June and July showed continued cooling of inflation, while US consumption and other demand indicators showed marginal weakness; thus, the likelihood of additional rate hikes by major central banks has fallen sharply.
- Meanwhile, volatility outside of rates remains low overall. The credit market is stable, emerging market carry trades continue to succeed, and equity markets are grinding higher.
Goldman Sachs points out that these signals collectively support the market’s "carry trade narrative"—in an environment of cooling inflation, slow growth, and central bank easing, holding risk assets remains profitable. And whether carry strategies can continue to work in the future depends entirely on the direction of real yields.
Specifically, there are two possible paths:
- Path One (Optimistic): Weakening demand leads to further decline in inflation, the Federal Reserve gradually gets confirmation and starts cutting rates, real yields move towards 2.00%, confirming a cross-asset bull market structure, and the logic that "bad news is good news" remains in play.
- Path Two (Risk): Economic growth slows, but real yields do not decline significantly. Sticky inflation, rebuilding of term premiums, persistent fiscal pressures keeping long-term yields high, or a Fed unable to deliver the amount of easing priced in by markets—all could result in weaker growth but insufficient fall in real yields, representing the least comfortable quadrant for risk assets.
Why Are Real Yields Not Falling? Five Structural Factors Forming Suppression
Despite recent signs of cooling in consumption data, real yields remain elevated. Goldman Sachs analysis points to a combination of multiple factors behind this:
1. Persistent fiscal pressures. Large deficits, rising debt service costs, and heavy sovereign bond supply are pressuring clearing prices for long-duration government bonds. Even in a slowing economy, investors might demand higher duration compensation.
2. Doubts over policy credibility. If the market begins to question the ability of fiscal or monetary policy to anchor inflation and debt dynamics, then weak economic growth does not automatically translate into lower long-end yields—"credibility premium" may offset the normal cyclical demand for duration.
3. Term premium may be rebuilding. After years of quantitative easing suppressing long-term rates, anchored inflation expectations, and highly predictable policy functions, investors may now require greater compensation for inflation volatility, fiscal uncertainty, and supply risks. This means real yields could remain higher for longer than post-2008 levels would suggest.
4. Massive capital expenditures on AI and data centers are changing the investment backdrop. Large-scale spending on data centers, power infrastructure, and AI computing may be persistently boosting demand for real assets, in turn supporting equilibrium real yields at higher levels.
5. Oil prices returning above $90 add complexity to the inflation narrative. Rising energy prices make a smooth disinflation path and a linear rate cut cycle more difficult to achieve.
The combination of these factors points to an important conclusion: the current 2.50% real yield may not simply be a temporary cyclical overshoot, but partly reflects higher fiscal risk premium, higher term premium, more persistent inflation volatility, and stronger structural capital demand.
If this judgment holds, the downside room for real yields will be much more limited than the market expects. Additionally, it's worth noting that inflation breakeven rates have not shown significant upside.
Historically, the market has been able to digest high real yield environments mainly because they were accompanied by rising breakevens and stronger nominal growth to offset the impact; this offsetting mechanism is largely absent today.
Do Not Fight the Carry Narrative For Now, But Exercise Cautious Position Sizing
On a strategy level, the Goldman Sachs Vitali Meschoulam team makes it clear that they do not recommend actively fighting the carry trade narrative at this point—momentum remains strong, volatility is low, and the market continues to interpret weak data as a sign of future easing.
At the same time, the team emphasizes that position sizing should be controlled accordingly, and the trajectory of real yields should be seen as the ultimate arbiter.
The key indicator to watch is: whether the US 10-year real yield can move from the current 2.50% level towards the 2.00%–2.25% range. If this move materializes, it will provide a stronger foundation for stocks, credit, EM carry, and gold.
Conversely, if real yields stay in the 2.40%–2.60% range, risk assets will be increasingly dependent on a rate cutting cycle that is "visible in expectations but not yet reflected in long-term discount rates."
The market views economic slowdown as a reason to hold risk assets, but in the end, real yields are the ultimate arbitrator in this cross-asset contest.
