Explain what active bond managers assume about how future spot rates will evolve compared with today's forward rates
The idea
Forward rates embedded in today's prices are the market's break-even. If future spot rates turn out exactly as the forwards imply, every bond, whatever its maturity, earns the one-year rate over a one-year horizon. Active managers therefore compare their own view with the forwards, not with today's spot rates. If they expect future spot rates below the forwards, bonds longer than the horizon should outperform, so they extend maturity. If they expect spot rates above the forwards, they stay short. Rates can rise and a longer bond still earn at least the one-year return, provided the rise is no larger than the forwards already imply.
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