Long-term Treasury bond prices are about where they ought to be: they consist of a normal duration discount, plus a valuation term because they are a hedge against today's extra large risk of (some forms of) macroeconomic disaster, plus the standard expectations of future federal funds rate terms, plus a term for lowered long-term inflation expectations in the future.
The Taylor Rule And The “Bond Bubble”: Here’s a thought for all those insisting that there’s a bond bubble: how unreasonable are current long-term interest rates given current macroeconomic forecasts?... I decided to use the simplified Mankiw rule, which puts the same coefficient on core CPI inflation and unemployment... the Fed funds rate is a linear function of core CPI inflation minus the unemployment rate... a scatterplot for 1988-2008.... Now, take the CBO projection, which calls for unemployment to fall very slowly, and core inflation to stay low for quite a while too. Here’s what it implies... four years of near-zero short-term interest rates. Does a 10-year rate of 2.6 percent still sound so unreasonable? And bear in mind that I’m not using some doomsayer’s forecast; I’m using the staid folks at the CBO.... I asked what interest rate on a 10-year security would yield the same present value as investing in short-term debt at the predicted rates, and rolling it over each year... 2.6 percent.
Here’s what I think is going on: aside from the obviously intense desire of some of the bond bubble folks to see a fiscal crisis — they’ve been planning for it, and they’re not going to take no for an answer — my sense is that a lot of people just can’t bring themselves to face the reality that we’re likely to be in a zero-interest world for a long time. They just keep assuming that the Fed is going to raise rates soon, even though there is absolutely nothing about the macro situation that would justify such a rate increase. But once again: if you take standard economic forecasts seriously, they point to near-zero short-term rates for a very long time, which in turn justifies low longer-term rates.