Predicting Interest Rates—An Empirical STUDY

PREDiCTinG inTEREST RaTES— an EMPiRiCal STUDY By John Silvia and azhar iqbal Explores the best way to predict the ten-year Treasury rate … expects the Treasury rate to reach 3.50% over the next two years … inflation (CPI), leading indicators, federal funds rate, and Federal government deficit are good predictors of the Treasury rate. O O ver the last two years, we have experienced a sequence of rise and fall in the ten-year yield (Figure 1) that belies the oft-stated view that interest rates have been steadily declining and that interest rate volatility is a relic of the past. Here we pose an alternative view that interest rate movements reflect movements in the underlying fundamentals over the business cycle rather than the result of some secular market forces that move rates lower over time. Moreover, our approach deals directly with the drift in the average values of Treasury rates, which is frequently overlooked by the current forecasting community. We test the changes in the ten-year Treasury yield that reflect the influence of its own past values, as well as other independent factors that cause changes in the yield. We also identify key factors that tend to cause ...