Expectations Theory

Expectations Theory is a financial concept that suggests the interest rates on long-term loans are determined by the market’s expectations of future short-term interest rates. Essentially, if investors believe short-term rates will rise in the future, they will demand higher yields on long-term investments now. Conversely, if they expect rates to fall, long-term yields will be lower. This theory helps explain how interest rates are structured and reflects investor sentiment regarding economic conditions, inflation, and central bank policies.