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How Are Long-Term Rates Likely to Evolve?
 

How Are Long-Term Rates Likely to Evolve?

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Rates on all interest bearing assets are very low, both short term and long term CD rates and bond yields are low. The Federal Reserve Chairman, Ben S. Bernanke, gave a speech recently at the Annual Monetary/Macroeconomics Conference. In the speech entitled "Long-Term Interest Rates," he spoke about why long term interest rates are so low and how long term rates will evolve in the future.

The first obvious reason for long term bond yields being so low is central banks are keeping yields low to increase growth. Movements in long-term interest rates in Canada, Germany, Japan, the United Kingdom, and the United States have been very similar over the past ten years. With the exception of rates in Japan, long term rates have declined in tandem over the past ten years and are all near 2 percent.

Movements in yields are very similar, despite the fact that there are differences in each country's economy and different central bank mandates. The financial crisis caused central banks to move interest rates down to record lows to foster growth, which has caused long term bond yields to also fall to record lows.

How Are Long-Term Rates Likely to EvolveNow that the crisis is behind us and economic growth is increasing, interest rates will start increasing again and return to normal levels. Current 10 year bond yields in the United States are at 1.85 percent and will rise to the 4 percent to 5 percent range by 2017, depending on the forecast.

On the high end of forecasts, the Congressional Budget Office (CBO) forecasts yields to increase to just above 5.00 percent. The Term Structure Model forecast predicts 10 year yields will rise to the 4.25 percent. You can view forecasts in the graph to the right:

When long term bond yields return to a more normal historical level, interest rates on savings accounts and certificates of deposit will rise as well. 5 year bank CD rates will also increase to a range of 4 percent to 5 percent. Right now the highest CD rates on 5 year certificates of deposit rates are just below 2.00 percent.

Where shorter term CD rates will be depends on where short term bond yields will be, which depends on the inflation rate. The current inflation rate is around 2.00 percent and the best CD rates on 1 year certificates of deposit are at 1.04 percent. Short term CD rates in 2017 will probably be slightly higher from current levels - around the 1.50 percent to 2.00 percent range.
Author: Monica Harris
March 4th, 2013