Modern markets are choreographed by a small set of forces that rarely sit still long enough to admire. Inflation sets the backdrop, interest rates translate that backdrop into a price for time, and risk assets respond with their usual mix of rational discounting and human mood. If you’re trying to navigate the next year rather than the next headline, it helps to think in a triangle: inflation, rates, and risk assets. The edges are short, the feedback loops are real, and small shifts can ricochet faster than commentary can catch. The payoff from framing it this way is not a prophetic model. It’s a cleaner map from macro signals to portfolio choices.
🟦 The Macro Triangle — a quick orientation
The triangle is simple enough to sketch. One corner is inflation, both what’s printed and what’s expected. Another is rates, in their three flavors: policy rates at the short end, term yields along the curve, and the real yield you get after inflation. The third corner is risk assets: equities, credit, real assets like commodities and real estate, and new entrants like crypto. A change in any corner presses on the others.
The practical claim is humble. Markets care about the whole shape, not any one vertex in isolation. When inflation rises, central banks choose whether to lean against it and how loudly. That choice shifts nominal yields and real rates, which feed into discount rates and financing costs. Risk assets reprice based on the new cost of capital and the new outlook for growth. The loop continues when asset prices, in turn, influence the economy through wealth effects and funding conditions, which then influence inflation and policy.
Thinking in this integrated way prevents common traps. You stop asking if inflation is “good or bad” for stocks and start asking which inflation, handled how, at what level of real yields, with which risk premia attached. You also notice when one leg moves faster than the others, which is usually where portfolio opportunities and potholes sit.
This is not a new idea. What’s changed is the speed and amplitude with which the triangle flexes. The same signal that once took quarters to play through can now hit your P&L in days.
🟦 Anatomy: what each corner means and how they talk to each other
Inflation has two lives. There’s the measured past—headline and core CPI or PCE—and the priced future—breakeven inflation in TIPS, inflation swaps, survey expectations. The past moves policy credibility. The future sets the real rate embedded in every asset price. Both matter, and both can diverge.
Rates are not one thing either. The policy rate is the lever central banks pull. The term structure translates that lever into a market view of growth, inflation, and term premium. Real rates strip out inflation expectations and tell you the pure price of time and safety. In practice, a cycle is often defined by which component is moving: policy, term premium, or real yield.
Risk assets live at the corner where valuation meets cash flow. Equities are sensitive to both the discount rate applied to future earnings and the earnings path itself. Credit adds an extra layer: the spread you demand to bear default and liquidity risk. Real assets respond to expected inflation, real yields, and the cost of carry. Crypto behaves more like a high beta liquidity asset, with occasional macropolitical overlays.
Transmission happens through three main channels. First, discounting: change the real rate and you change the present value of distant cash flows. Growthy equities and long-duration assets feel it most. Second, risk premia: when volatility rises and credit spreads widen, risk assets demand higher compensation for uncertainty, which can overwhelm the pure rate effect. Third, real-economy pass-through: wages, margins, and fiscal policy move profits, which either validate or contradict what discounting alone would have done.
Here’s a compact checklist of channels that deserve a permanent spot on your dashboard:
- Discounting: real yields up, present values down; duration is the fulcrum.
- Risk premia: volatility, spreads, and liquidity conditions modulate the rate shock.
- Real-economy pass-through: wages, pricing power, and fiscal impulse shape earnings.
The trick is noticing when the channels reinforce each other versus when they offset. A rise in real yields during an earnings upgrade cycle can leave indexes flat while undercutting unprofitable growth. A fall in yields during an earnings downgrade can lift valuations but not enough to prevent drawdowns in cyclical sectors.
💡 Why this triangle matters more now than in recent decades
The post‑2020 mix has shortened the fuse. Massive fiscal support altered the usual sequencing between policy and demand. Central banks ran ultra‑loose, then tightened at historic speed. Supply shocks and re‑shoring reframed the cost base. The result is a regime with higher nominal and real rate volatility, wider error bands around inflation, and faster transmission into prices.
Classical playbooks—long bonds as ballast, equities as growth, commodities as inflation hedge—still work in direction, but their reliability has faded. When fiscal policy stays active across the cycle, the term premium becomes more volatile, and long duration can be a source of risk rather than a hedge. When supply shocks drive inflation, rate hikes cool demand but don’t fix bottlenecks quickly, which stretches the lag between policy and inflation outcomes. When globalization slows, the elastic band that held down goods prices and held up margins loosens.
More practically, the cost of being directionally wrong has risen. A two standard deviation move in real yields used to be a quarterly event. In this regime it can be a Tuesday. The market now prices policy mistakes and alternative steady states more readily, which means convexity and humility are worth more than they used to be.
⚙️ Common misconceptions that distort decisions
Myth 1: Inflation is uniformly bad for stocks. The nuance: low to moderate inflation driven by demand can coincide with rising nominal revenues and stable margins, which support equities even as rates rise. The pain arrives when inflation lifts real rates or compresses margins—especially if it forces a policy response that tightens financial conditions faster than earnings can grow.
Myth 2: Only policy rate moves matter. Market rates matter as much. The 10‑year real yield, the slope of the curve, and the term premium can change independent of a central bank meeting. Risk assets care about funding costs and discount rates wherever they move on the curve.
Myth 3: Equities always hedge inflation. Some sectors do better than others. Energy, materials, and select real assets can offset inflation periods, but many companies lose pricing power as inflation persists. Equities hedge inflation best when inflation is stable, growth is healthy, and real rates are low.
Myth 4: Central banks always win the inflation fight. They usually do over time, but the path is messier than the narrative. Policy lags are variable, supply shocks are stubborn, and political constraints matter. Markets can endure multi‑quarter periods where inflation expectations and real yields drift in ways that challenge both mandates.
Myth 5: Rates up equals recession. Sometimes rates rise because growth expectations improve. In those episodes, credit can tighten spreads even as yields rise. The danger is when rates rise for the wrong reasons—rising term premium or inflation fears with weakening growth.
🟦 How the triangle moves markets — indicators and empirical levers
Translating the triangle into a dashboard is where the work pays off. The essential metrics are simple. Watch 10‑year nominal yields and 10‑year real yields. Track breakeven inflation from TIPS and the slope of the yield curve. Monitor credit spreads—investment grade and high yield—and compare the equity earnings yield with bond yields. Layer on liquidity signals from fund flows, repo conditions, and high‑frequency measures like the MOVE index for rates volatility.
Those pieces form a read on whether the market is digesting a rate shock, pricing sticky inflation, or bracing for a growth slowdown. Rising real yields with stable breakevens suggest a pure discount‑rate move, which typically pressures long duration equities and supports value and financials. Rising breakevens with stable real yields flag inflation expectations, which often favors commodities, TIPS, and cash‑flow generative cyclicals. Widening credit spreads with a bull‑steepening curve point toward growth concern, which favors quality balance sheets and longer duration bonds.
Flows and plumbing deserve respect. Tightening repo conditions and negative fund flows into credit and small caps usually amplify whatever the rate signal is saying. Conversely, generous liquidity—think elevated reverse repo balances draining into risk—can buoy asset prices even as macro looks muddy. Reading the triangle is as much about these amplifiers as the initial move.
🟦 Case studies and patterns: market episodes that teach the model
The 2013 Taper Tantrum was a classic policy‑surprise rate shock. The first move was communication: the Fed hinted at slowing asset purchases. Term premium jumped, 10‑year yields rose, real yields surged. Risk assets repriced quickly. Long duration equities underperformed, emerging markets saw outflows, and credit spreads widened. Inflation expectations moved little. The lesson: language that shifts term premium can deliver a valuation shock without a big change in growth.
The 2018–19 tightening cycle was more gradual but instructive. Policy rates rose steadily, the curve flattened, and by late 2018 liquidity was tight. Real yields peaked. Risk assets hit an air pocket into December as the discount‑rate channel collided with growing concerns about earnings. The pivot in early 2019—softening guidance on rate hikes—released pressure, real yields fell, and assets recovered. Translation: when real rates retreat without a collapse in earnings, duration comes back to life.
The 2020 liquidity‑driven rally flipped the usual script. Real activity collapsed, policy went maximal, and real yields fell sharply. Risk premia narrowed as backstops multiplied. Equities and credit rallied even as the economy healed slowly. Liquidity and discounting overpowered near‑term earnings reality. It was a reminder that the triangle sometimes compresses to a single dominant edge.
The 2021–22 inflation surge and 2022 rate shock were a stress test. Inflation prints surprised upward, breakevens rose, then policy shifted from patience to speed. Real yields climbed from deeply negative to positive territory. Long duration equities and speculative assets suffered, credit spreads widened, and bond‑equity correlation flipped positive at the worst time for balanced portfolios. Margins compressed where pricing power was weak. The chain ran from inflation to real rates to risk premia to profits.
In 2023, resilience came by way of falling real rates and a narrower market. Inflation cooled from extremes, policy approached restrictive territory, and markets priced a slower path ahead. Real yields peaked mid‑year then eased, lifting long duration growth while value and cyclicals lagged. Credit spreads stayed contained, which kept financial conditions supportive. The year illustrated that even late in a tightening cycle, a modest fall in real yields can ease the discounting headwind enough to keep risk bid.
🟦 Data you should look at and how to interpret it (practical checklist)
The point is not to build an elaborate model. It’s to align a focused set of indicators with the channels that move the triangle. Pair slow‑moving fundamentals with higher‑frequency market reads so you catch regime changes without trading every wobble.
| Indicator | What it tells you | Beware |
|---|---|---|
| Headline/Core CPI, PCE | Realized inflation trends | Base effects and revisions |
| 5y5y inflation swaps, TIPS breakevens | Long-run inflation expectations | Liquidity premia in TIPS |
| 10y nominal and real yields | Discount rate pressure on valuations | Short squeezes in duration |
| Yield curve slope (2s/10s, 3m/10y) | Growth expectations and policy stance | Term premium distortions |
| Term premium estimates | Compensation for holding duration | Model uncertainty is high |
| Wage growth, unit labor costs | Margin pressure risk | Industry-level dispersion |
| Credit spreads (IG, HY), CDS indices | Risk appetite and default risk | Energy weight, rating mix |
| Earnings revisions, breadth | Profit cycle direction | Analyst herding and seasonality |
| Liquidity: ETF/mutual fund flows, repo/MOVE | Amplifiers of rate and risk shocks | Short-term noise and flows |
Two practical habits: look at six‑ to twelve‑month trends for anchoring, then read weekly changes for fresh information. And translate each move into a channel. A 25 bp rise in real yields with flat breakevens is a discounting story. A 25 bp rise in breakevens with flat real yields is an inflation expectations story. Widening spreads with falling yields is a growth story. The portfolio implications differ.
🟦 Counterarguments and alternative regimes to plan for
No framework survives contact with the future unless it makes room for alternatives. Four regimes are worth keeping on the board.
Renewed disinflation or outright deflation. If growth slows and inflation falls back toward or below target, real yields may fall on expectations of easier policy. Duration rallies, quality growth outperforms, credit does fine until defaults rise. Commodities and cyclicals lag.
Persistent high inflation with policy error. If inflation stays elevated while policy stays too easy, breakevens rise, real yields may stay subdued, and nominal yields drift up. Commodities, real assets, and value with pricing power help. Long duration and unprofitable growth struggle. Currency dynamics matter more.
Higher neutral rate steady state. If the economy settles into a world with a higher equilibrium real rate, multiples compress a bit, but profits can still grow. Value and cash‑generative quality at reasonable prices stand out. Bonds hedge less. Cash earns a return again.
Stagflationary shock. If growth slows while inflation reaccelerates, both real yields and breakevens can move in awkward ways and risk premia widen. Quality balance sheets, TIPS, select commodities, and convex hedges become the toolkit. Diversification works harder across uncorrelated exposures rather than within equities alone.
Treat these as scenario nodes, not predictions. Positioning for robustness favors optionality, the ability to add risk when the triangle clarifies, and a plan for what to sell when it doesn’t.
🟦 Practical conclusions: portfolio rules, hedges, and monitoring protocol
If you strip the triangle down to working rules, three stand out. Position by real‑rate and breakeven regime. When real yields fall and growth is stable, lengthen duration in equities and bonds. When breakevens rise with anchored real yields, lean into real assets, value, and TIPS. When both real yields and spreads rise, play defense and protect liquidity.
Build hedges where the triangle bites. TIPS are a clean hedge to inflation surprises. Short‑duration credit tempers rate risk while collecting spread. Options provide convexity against tail events on either side—a sharp rate spike or a growth air pocket. Small, repeatable hedges beat grand gestures that arrive a month late.
Run a monitoring protocol you can keep. A weekly review of inflation expectations, 10‑year real yields, curve slope, and credit spreads, plus a glance at earnings revisions and liquidity flows, covers most of the triangle. Set explicit rebalancing triggers tied to those indicators rather than to headlines. When signals conflict, cut size rather than conviction.
Two closing notes. First, this is a dynamic map, not a doctrine. The same signal will land differently at 1 percent real yields than at 3. Second, size your convictions modestly. The market’s next regime shift tends to arrive faster than your post‑mortem. Check how disciplined your portfolio really is.
📚 Related Reading
– Inflation, Profits, and Pricing Power: How Margins Survive a Hot Economy — https://axplusb.media/inflation-profits-pricing-power
– Bond Math in a Volatile World: Real Yields, Term Premium, and the New Duration — https://axplusb.media/bond-math-real-yields
– Liquidity Isn’t an Abstraction: Flows, Repo, and the Price of Risk — https://axplusb.media/liquidity-flows-repo