Weekly update - U.S. Rates: The Arithmetic of Nominal Growth

The U.S. 10-year Treasury yield has exceeded 5.3%, its highest level since 2002. This level may seem particularly high after more than a decade of very low interest rates. However, it should be considered in light of the strength of the U.S. economy: in the second quarter, nominal growth reached 8.5% on an annualized basis. Taken in isolation, this figure could justify even higher interest rates. But one quarter is not enough to define a trend. The real question is whether the United States has entered a lasting period of stronger nominal growth

Over the long term, a classic relationship suggests that interest rates tend to move close to nominal growth,  that is, real growth plus inflation. This relationship compares, in a simplified way, the cost of “risk-free” financing with the growth of income generated by the economy. According to the third estimate of second-quarter GDP, the economy grew by 8.5% in current dollars on an annualized basis. This breaks down into real growth of 2.2%, revised upward from the previous estimate of 1.5%, and a GDP deflator increase of nearly 6%. Compared with a 10-year yield of 5.3%, the gap therefore exceeds three percentage points in favor of nominal growth. If this pace were to continue, borrowing at these levels would remain relatively attractive, and higher long-term rates would not necessarily be incompatible with the economy’s momentum.

This comparison must nevertheless be handled with caution. The 10-year yield does not reflect past-quarter growth, but rather expectations for future growth, inflation, and monetary policy. Yet nominal growth is volatile: it was “only” 5.1% in the first quarter. Its composition also matters. More than two-thirds of the increase recorded in the second quarter came from prices, in the context of an energy shock, while core inflation remained more moderate, with the PCE index excluding food and energy rising by 3.3% annually. Nominal growth driven mainly by energy is inherently fragile: it erodes purchasing power and can quickly fade if oil prices decline. Therefore, it is not the 8.5% figure itself that matters most for assessing the equilibrium level of long-term rates, but rather the underlying trend in nominal growth.

It remains possible that the nominal regime of the U.S. economy has changed permanently. During the 2010s, moderate real growth, inflation often below the Federal Reserve’s target, and highly accommodative monetary policies created an environment of exceptionally low interest rates. Today’s context is different. Inflation remains higher, economic activity is resilient, public deficits support demand, and investment linked to new technologies could sustain stronger real growth. If nominal growth now stabilizes around 5% to 6%, rather than the very low levels of the previous decade, then a 10-year yield near 5% would appear less exceptional. Such a new regime would not be neutral for financial markets. It would weigh on real estate credit, gradually increase refinancing costs for indebted borrowers, and require higher discount rates for long-term assets. For investors, the challenge is therefore no longer simply to anticipate the Federal Reserve’s next decision, but to determine whether the return of long-term rates above 5% is a temporary tension or the new equilibrium of a more dynamic, value-driven U.S. economy.

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