Nominal rates (what you see quoted) aren't what matter for economic decisions. REAL rates — nominal rates minus inflation — are what actually drives behavior.

The Formula:

Real Rate = Nominal Rate − Inflation Expectations

Example: If the 2Y yield is 4% and expected inflation is 2%, the real rate is 2%. That's the TRUE cost of borrowing.

Why Real Rates Matter:

Businesses and investors don't care about nominal rates in isolation. They care about the REAL return — what they get after inflation erodes purchasing power.

• High Real Rates (> 1.5%): Money is 'expensive.' Borrowing costs are real, not inflated away. Investment hurdles are high. Speculative assets suffer.

• Low/Zero Real Rates: Money is 'free.' Borrowing costs are offset by inflation. Easy to beat hurdle rates. Speculation encouraged.

• Negative Real Rates: You're PAID to borrow in real terms. Inflation erodes debt faster than interest accumulates. This is what we had 2008-2021. It fueled massive asset bubbles.

Passive Tightening:

Here's the trap: Real rates can rise even if the Fed does NOTHING.

If inflation falls faster than the Fed cuts rates, real rates rise automatically. This 'passive tightening' can slow the economy without any Fed action. The Fed has to cut just to keep real rates stable when inflation falls.

The 2022 Real Rate Shock:

Real rates went from -1% (2021) to +2% (2022) — a 3%+ swing. This was the fastest real rate increase in decades. It explains why growth stocks and crypto got crushed: the hurdle rate for speculative assets suddenly became very real.