My best guesstimate is that long rates aren’t going to move much from here (maybe decline a bit) but that short rates will decline next year and into 2008. The high inflation we’ve seen over the past 10 years is in the PAST (by definition) – it’s probably over for a while. So, while the government’s been reporting 3% inflation, the real rate has probably been more like 5% after adjusting for hedonics, substitution effects and the use of owner-equivalent rents (instead of housing prices). But now housing prices are already high (and moving lower), oil is already high (and probably won’t be increasing at the same rate it has over the last few years), commodities are already high (and not increasing at the same rate as the last few years)… you get the picture. So, the big inflation moves have probably already happened for this long cycle. My guess is that for the next 5-10 years the reported inflation figures will actually be roughly what the real inflation rate is, or 3%-ish. Housing prices will decline but it won’t show up in the CPI because use of owner-equivalent rents smoothes the series on both the upside and the downside. Commodities may increase but at a decreasing rate. We’ll probably get a bit of import inflation due to a declining dollar but I don’t think it will offset the other stuff. So, again, it’s just a guess but I think the “real” inflation rate is actually going to be reasonable over the next 5-10 years, which means short rates would decline 150-200 bps over time and long rates would stay about where they are, give or take 50 bps. The problem is for those people who have owned fixed income over the last decade, because interest rates were set by the market based on the government’s reported inflation figures, which were much lower than the real inflation rate. These people have been screwed and don’t fully know it (although they may sense it when they look at prices around them). But that’s the past; that doesn’t matter going forward.
