Market Segmentation Theory
What It Is:
Market segmentation theory posits that the behavior of short-term and long-term interest rates are mutually exclusive.
How It Works/Example:
Market segmentation theory suggests that the behavior of short-term interest rates is wholly unrelated to the behavior of long-term interest rates. In other words, a change in one is in no way indicative of an immediate change in the other. Both must be analyzed independently. Accordingly, the yield curve reflects the market supply and demand for Treasury bonds of a certain maturity only.
Why It Matters:
Market segmentation theory suggests that it is impossible to predict future interest rate outcomes based on short-term interest rates. Moreover, long-term interest rates (for example, the rate of the 30-year Treasury bond) only express market expectations and do not indicate that a definite outcome will occur.