The Fisher Effect states that the real interest rate equals the nominal interest rate minus the expected inflation rate. Therefore, real interest rates fall as inflation increases, unless nominal rates increase at the same rate as inflation.

The real rate of return formula is the sum of one plus the nominal rate divided by the sum of one plus the inflation rate which then is subtracted by one. The formula for the real rate of return can be used to determine the effective return on an investment after adjusting for inflation.

Real rate of return is the annual percentage of profit earned on an investment, adjusted for inflation. Therefore, the real rate of return accurately indicates the actual purchasing power of a given amount of money over time.

It’s also seen as a sign of investor sentiment about the economy. A rising yield indicates falling demand for Treasury bonds, which means investors prefer higher-risk, higher-reward investments. A falling yield suggests the opposite.

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Rising yields may signal that investors are looking for higher return investments but could also spook investors who fear that the rising rates could draw capital away from the stock market.

Why are yields rising? The Federal Reserve cut interest rates to near-zero levels in March to spur borrowing and kick the economy out of a pandemic-fueled recession. Yields across maturities hit record lows. The yield on the 30-year Treasury bond overnight Monday rose to 2.006%, its highest since February 2020.

Treasury yields are basically the rate investors are charging the U.S. Treasury for borrowing money. When investors are more wary about the health of the economy and its outlook, they are more interested in buying Treasurys, thus pushing up the prices and causing the yields to decline.

If investors expect a recession, for example, bond prices are generally rising and stock prices are generally falling. This also means that the worst of a stock bear market typically occurs before the deepest part of the recession.

As fixed income investors, we expect 2021 to be a year of recovery. Rising yields of course mean falling bond prices—at least on paper for investors who own the debt. But yields will be rising for good reasons, based on economic growth and cash flow returning to markets.

First, bonds, especially government bonds, are considered safe haven assets (U.S. bonds are thought of as “risk free”) with very low default risk. The downside is that they are “risk assets” that generally fall out of favor during a recession and can swing wildly in value over the short term.

Looking at the S&P 500 for the years 1991 to 2020 1990 to 2019, the average stock market return for the last 30 years is 9.87%. Some of this success can be attributed to the dot-com boom in the late 1990s (before the bust), which resulted in high return rates for five consecutive years.