Kresnak noted that we are in an unusual market and economic environment, which is likely to mean that the Fed will raise interest rates over the coming years to levels not seen since before the global financial crisis. Although the recent events in Ukraine and uncertainty about the effects policy normalization will have on the broader economy raise the risks that rates may not rise as much as we anticipate, it is unlikely that they will stay at or below current levels due to high inflation rates.
This environment is likely to lead to rising real interest rates, which differ from nominal interest rates in that real rates are adjusted to remove the effects of inflation. The VCMM team investigated how some sub-asset classes performed during rising real rate environments and what drove performance. Given Vanguard’s expectation that the Fed may raise the nominal rate to 3%, the team focused on similar periods with relatively large rate hikes that also led to spikes in real rates.
The analysis examined a mix of economic environments during which real rate increases occurred, including during an improving economy in 1992–1994 and a period of low growth and low interest rates in 2014–2019.
“It was important to include a wide range of economic cycles to capture as many of the conditions that exist today,” Kresnak said. “This allows us to get a better understanding of how and why different sub-asset classes performed.”
The team's research resulted in three key findings: