Ben Bernanke's blog - important reading

The Fed’s ability to affect real rates of return, especially longer-term real rates, is transitory and limited. Except in the short run, real interest rates are determined by a wide range of economic factors, including prospects for economic growth—not by the Fed.

The bottom line is that the state of the economy, not the Fed, ultimately determines the real rate of return attainable by savers and investors. The Fed influences market rates but not in an unconstrained way; if it seeks a healthy economy, then it must try to push market rates toward levels consistent with the underlying equilibrium rate.

-Ben Bernanke's new blog

Those quotes are from the first posting of Ben Bernanke's new blog for the Brookings Institute. It is quite interesting to have the former Fed Chairman say that the Fed cannot affect interest rates. Of course, the comments are true in the long-run, but the Fed has always been trying to push rates above or below the neutral or equilibrium rate to hit its long-term targets. This is the measure of tight or loose monetary policy.

This is discussion on the level of the neutral rate and how rates are determined is the critical issue of 2015. If the neutral rate of interest has fallen and is closer to zero, then the Fed will and should keep rates lower for a longer period of time. Raising rates will create a tightening bias. Normalization under a low neutral rate will not require significant rate hikes. If the neutral rate is closer to the long-term trend in growth or 2%, then rates will  have to move much higher for normalization. 

If the neutral rate is closer to zero, then bonds are really not overvalued. Investors should be less worried about a bond bubble. The right determination of the neutral rates is what every investor should be thinking about at this time.