Kamakura Announces 10 Year Monthly Forecast of U.S. Treasury Yields and Swap Spreads for October, 2010

New York - 19 October 2010

Kamakura Corporation on Tuesday released its forecast for U.S. Treasury yields and interest rate swap spreads monthly for the next 10 years. The forecast this week continues to show a dramatic flattening of the U.S. Treasury yield curve, but implied forward 1 month US Treasury bill rates have shown a dramatic twist, dropping in the intermediate term and rising on the long end of the yield curve. U.S. dollar Libor-swap spreads to the U.S. Treasury curve also continue to imply short term Libor rates below the matched maturity U.S. Treasury yield for years into the future starting in 2016.

The Kamakura forecast for October shows 1 month Treasury bill rates rising steadily to 4.52% in the September 2010, up 18 basis points from the peak forecasted last month. The 10 year U.S. Treasury yield is projected to rise steadily to 5.09% on September 30, 2020, 20 basis points higher than forecasted last month. The negative 46 basis point spread between 30 year U.S. dollar interest rate swaps and U.S. Treasury yields reflects the blurring of credit quality between these two yield curves. The U.S. government is no longer seen as risk free, and 4 of the 16 panel banks that determine U.S. dollar libor are receiving significant government assistance and are, in effect, sovereign credits. For more on the panel members, see www.bbalibor.com. The negative 30 year spread results in an implied negative spread between 1 month libor and 1 month U.S. Treasury yields (investment basis) beginning in April 2016 and persisting through the rest of the ten year forecast.

Kamakura Washington DC Representative David Boldon said Tuesday, “Kamakura continues to believe that the relationship between US Treasury yields and the libor-swap curve has been seriously distorted as a result of the credit crisis. We believe that these distortions are related to both changing credit quality of the banks underlying the libor quotations and substantial differences between quoted libor rates and actual funding costs. As a result, we continue to advise clients that libor-related hedging programs have more basis risk versus real funding costs than ever before.”

The projected flattening in the U.S. Treasury yield curve projected in the Kamakura rate forecast is shown below in Fig1. The negative spread between interest rate swaps and US Treasuries implies an extended period of negative spreads between the Libor-swap curve and Treasuries and dramatic spread gyrations around year end 2010.

The full text of the Kamakura forecast for U.S. Treasury yields and interest rate swap spreads is available each Friday afternoon on the Kamakura blog.

The Kamakura interest rate forecasts are based on the forward interest rates embedded in the current U.S. Treasury yield curve and in the interest rate swap curve. These forward rates are extracted using the maximum smoothness forward rate approach first published by Kamakura’s Donald R. van Deventer and Kenneth Adams in 1994 and modified in Financial Risk Analytics (1996) by Kamakura’s Imai and van Deventer. The maximum smoothness approach is applied directly to forward rates in the case of U.S. Treasury yields and it is applied to forward credit spreads, relative to the U.S. Treasury curve, in the case of the swap curve.

Become a bobsguide member to access the following

1. Unrestricted access to bobsguide
2. Send a proposal request
3. Insights delivered daily to your inbox
4. Career development