We present an enhanced model that combines these two types of expectations, allowing us to assess what is already priced in long-term bond yields. As of 26 November, the estimated fair value of 10-year U.S. treasury bonds is 1.79%. Our model shows that 0.62% of that is contributed by the current Federal Funds rate, 1.24% by its perceived value and -0.07% by its expected short-term change (against -0.50% in early September). In other words, long-term adaptive (or backward-looking) expectations about policy rates keep short-term forward-looking expectations on the leash.

This was seen in early September, when, having very much bought the rumor that rate cuts were coming, the U.S. bond market sold the news when the FOMC actually cut the Federal Funds target. Expectations about the FOMC’s next moves are now subdued. 

From a valuation point of view, our enhanced model confirms that the distribution of potential outcomes is now not skewed enough to warrant an aggressive positioning of portfolios in terms of duration.