Interest rate volatility part I: considerations in predicting interest rates

March 2022

In this two-part series, we identify core considerations for investors when determining how best to evaluate and manage interest rate risk. In part I, we set the stage by discussing compensated versus uncompensated risks, how forward curve considerations provide a benchmark for interest rate expectations, and how economists have performed at forecasting yields.

With these three points framing the paper, we arrive at several conclusions. First, in the absence of the term premium, taking on interest rate risk is an uncompensated risk. Second, forward yield curves provide an unbiased market view of the future direction of interest rates. This means that any investor who wants to take a view on the direction of interest rates would have to “out guess” the market by comparing their own interest rate predictions to those projected by the forward curve. Third, the economist community has performed poorly in predicting the future levels of interest rates, as their recent average bias was much higher than actual outcomes.

In part II of the series, we will outline strategies to consider capitalizing on interest rate volatility.

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