Kamakura Corporation on Monday announced its forecast for U.S. Treasury yields and interest rate swap spreads monthly for the next 10 years. The forecast shows a further decline in future interest rates on top of the large declines reported in the June forecast. Kamakura also announced that a new paper by Professor Robert Jarrow, âThe Economics of Credit Default Swaps,â is now available with registration in the research section of the Kamakura web site.
The Kamakura forecast for July shows 1 month Treasury bill rates rising steadily to 4.53% in June, 2020, down 14 basis points from the fourth quarter 2017 peak of 4.67% predicted in June. The 10 year U.S. Treasury yield is projected to rise steadily to 4.963% on June 30, 2020, 15 basis points lower than forecasted last month. The negative 22 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 2015 and persisting through the rest of the ten year forecast.
Kamakura founder Dr. Donald R. van Deventer commented on this weekâs forecast, âWe continue to believe that the negative US Treasury-swap spreads embedded in the current yield curve present considerable opportunities for the best informed fixed income investors. Over the last few weeks, implausible implied movements in the TED spread have begun to be arbitraged away and we believe this process will continue.â Commenting on Professor Jarrowâs latest research paper, Dr. van Deventer added, âWe have come a long way since credit default swap traders asserted that the credit default swap spread is simply equal to (1 minus the recovery rate) times the default probability. Professor Jarrow explains very clearly why credit default swap spreads are much higher than expected loss alone, using the economics of insurance as the basis for his arguments. We think this is a very important contribution to better understanding of credit derivatives markets.â
The Kamakura interest rate forecasts are based on the forward interest rates embedded in the current U.S. Treasury yield curve and interest rate swap curve. These forward rates are extracted using the maximum smoothness forward rate approach first published by Kamakuraâs Donald R. van Deventer and Kenneth Adams in 1994 and modified in Financial Risk Analytics (1996) by Kamakuraâs 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.