However, a far more important determinant of low bond yields today is the expectation that short-term rates will stay low, which in turn reflects expectations of low and persistent inflation and of a weak and uncertain recovery. Perhaps theory is useful here. Theory suggests that long-term interest rates should be a weighted average of expected short-term interest rates plus a term premium.
The premium should normally be positive, even in the absence of default risk. Longer-term securities are riskier than short-term ones, because their prices are volatile. Expected short-term nominal rates should be determined by expected real interest rates and expected inflation, and expected changes in real interest rates should, in turn, be determined by the expected balance of savings and investment.