Interest Rates and Stock Prices: A Fundamental Connection

The recent surge in interest rates has sparked an old debate about their relationship with stock prices. Some investors and market-watchers focus on the Federal Reserve's power to set interest rates, while others emphasize fundamental factors like inflation and real economic growth.

One key indicator of interest rates is the 'intrinsic risk-free rate', which combines inflation and real GDP growth in the US economy. According to data from the Federal Reserve (FRED), this rate has been a better predictor of long-term interest rates than short-term fluctuations in inflation.

In 2022, expected inflation dipped, but since then, it has increased. Despite rising oil prices and talk of inflation, the market's expectation of long-term inflation has only mildly increased, as seen in yields on US Treasury bonds.