A long, long time ago when I first arrived on Wall Street in the early 1960s, 10-year Treasury bonds were yielding 4%. Although nearly double current levels, 4% was considered quite normal at the time. But then a secular bear market in bond prices began as yields moved higher for nearly two decades. That bear market ended in the late summer of 1981 when yields for the 10-year Treasury peaked at almost 16%. It was a major inflection point in U.S. financial history as both a cyclical and a secular bull market in bonds began. Ever since, bond yields have been in a very long but irregular downtrend, peppered by cyclical swings around the secular decline, as was the secular bear market that preceded it.
I strongly believe that a similar turning point is at hand and that interest rates will again be rising for years to come. The abnormally low levels of the past few years are the result of central bank policies around the globe that were put in place to prevent the financial crisis from plunging the world into a deflationary spiral. With global inflation pressures once again on the rise, albeit from very low levels, the U.S. has already ended its QE and is now close to ending its zero interest rate policy as well, although Europe and Japan will continue on this track for a while longer.
The Fed has described the period going forward as one of a normalization of monetary policy. But their euphemistic use of that term begs the question of what exactly is normal. Put another way, how high might interest rates go to find normal levels? Here are three models to help find an answer . . .