Schweser says that a portfolio manager expects the central bank to loosen monetary policy, resulting in a small reduction in real interest rates and a large increase in inflation expectations. The small fall in real rates and large increase in inflation expectations will raise interest rates and reduce bond prices and returns. What is the difference between real interest rate and interest rate here? How is it that a small fall in real interest rates can lead to a rise in interest rates?
The central bank can only control overnight rates, that’a a 1-day rate. While bonds are much longer than that.
The O/N rate is a real rate, because there is not enough time for inflation to affect it, while this is not true for long term rates. If inflation is expected to rise because of the drop in short term rates, then long term rates can go up, rotating the curve counterclockwise.