IVOL - How High Are Interest Rates Heading?

• The historical average real yield has been 2.25%. That means that if the Federal Reserve manages to keep inflation at its 2% target, a historically typical yield on 10-year Treasury notes would be 4.25%.
• Assuming that we are in for a prolonged period of modest (but positive) real yields, say 1%, and that inflation does average 2%, it seems reasonable to expect 10-year Treasury yields to continue their climb until they reach at least 3%.
• Assuming real GDP growth of 1%-2% over the long term, and inflation of 2%, the implied fair value for 10-year Treasury note yields should be in the 3%-4% range, consistent with yield projections based on inflation alone.
• I take the Fed at its word that it will not increase short-term rates until the markets force its hand. The implication is that investors should not commit to long-term bonds (or to fixed lifetime annuities) until 10-year yields touch 3%.
• Although I cannot predict when the Fed will be forced to tighten, the bond market will probably give notice some weeks in advance.

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