Under the Hood: Strong Demand, Higher Real Rates, and What It Means for Portfolios

Jobs Growth: Slower but Steady

Over time, growth in real GDP roughly equals the combination of productivity growth and labor force growth, and employment growth tracks the labor force (exhibit 1). When the business cycle rolls over, recessions push unemployment higher, and then recoveries bring it back down.

In more normal periods like today, hiring broadly matches the labor force growth, and unemployment holds steady. Labor force growth has slowed to about 0.5% a year, so payroll gains have slowed too. Payrolls rose only 29,000 in September and averaged about 45,000 a month over the past year, yet unemployment is still a low 4.2%.

GDP Growth: Stronger Than the Headline

Global economic activity has accelerated as indicated by the rise in the J.P. Morgan Global Composite PMI to 54.3 in September, which is its fastest pace in three years. Domestically, the St. Louis Fed’s Q3 GDP Nowcast is at a healthy 2.7% while Atlanta Fed’s GDPNow model estimates third-quarter growth at 3.6% as of October 8th.

See more: Worried Consumers Keep Spending: Here’s Why

Still, we think the headline GDP understates the overall pace of U.S. economic momentum. Net trade (exports minus imports) detracts from U.S. GDP, and tariff timing and AI-related equipment imports have swung trade sharply. Real final sales to private domestic purchasers, often called “core GDP,” removes trade, inventories, and government spending to isolate the economic activity from households and businesses.

In the second quarter, headline GDP grew 2.2%, but core GDP grew 4.6%. That rate is well above the roughly 2% trend growth estimated for the post-2008 era. The U.S. also stands out globally as the IMF projects faster U.S. economic growth in 2026 and 2027 compared to the Eurozone, the U.K., and Japan.

Rates: A Growth & Supply Story Not Inflation

The 10-year Treasury yield increased from about 4.0% last October to over 5.0% today. At the same time, 10-year market-implied inflation expectations have bounced between roughly 2.2% and 2.4%. Therefore, almost all of the increase in yield comes from the real (inflation-adjusted) yield, which rose from about 1.7% to nearly 2.6%. Stronger economic growth explains part of the boost in real yields, but so does heavy Treasury issuance to fund deficits, competing AI-related corporate borrowing, and softer foreign demand for U.S. debt.

Near-term pricing pressures are genuine. Energy and transportation costs have pushed business input expenses higher at the fastest rate since 2022. Bond markets, however, see this as temporary, and the Fed’s recent rate hike reinforces its commitment to price stability. Steady long-term inflation expectations should be reassuring for households. Still, the interest expense on the federal debt will likely remain elevated for an extended period.

Investment Implications

Higher rates are a headwind for cyclical and rate-sensitive sectors. We continue to favor high-quality U.S. equities with consistent earnings growth, which is reflected in our overweights to information technology and health care. For our fixed income allocations, we favor the belly of the yield curve though we modestly extended duration after the latest rise in rates. Additionally, we maintain our emphasis on high-quality asset-backed securities for their yield and resilience. In an effort to manage volatility and diversify returns, we use equity option overlays and multi-asset real return strategies, which provide exposure to commodities and global infrastructure.

The Cash Indicator

The Cash Indicator (CI) currently reads 12.63, well below its long-term median of 25 and far from crossing a cash raise threshold. While the CI spiked temporarily during the Middle East conflict, it has since settled back down to low levels. Readings this subdued can reflect market complacency and can precede periods of higher volatility. Volatility could present a buying opportunity in our view.

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