Kamakura Releases 10 Year Monthly Forecast of U.S. Treasury Yields and Swap Spreads for July, 2011

Honolulu-based Kamakura Corporation on Tuesday released its forecast for U.S. Treasury yields and interest rate swap spreads monthly for the next 10 years. The forecasted 1 month US Treasury bill rates decreased in the short term and rose on the long end of the curve with a twist looking out ten to sixteen months.

The Kamakura forecast for July shows 1 month Treasury bill rates rising steadily to 5.243% in June 2021, up 15 basis points from the peak forecasted last month. The 10 year U.S. Treasury yield is projected to rise steadily to 5.429% on June 30, 2021, 14.5 basis points higher than forecasted last month. The negative 36 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 20 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 2018 to 2021.

Kamakura Chief Administrative Officer Martin Zorn said Tuesday, “The forward curve is reflective of the political gridlock that we have seen in Washington. The short end falls on recessionary fears, as debt talks stumble and the long end rises in reaction to supply and demand. When you throw in the European debt crisis, the forward curve is expressing state global of uncertainties. “

The negative spread between interest rate swaps and US Treasuries implies a period of negative spreads between the Libor-swap curve and Treasuries and dramatic spread gyrations around mid-2012, as shown in this graph. This distortion comes about because the Libor Swap curve has two components with dramatically different credit risk. The short term rates are from the Libor market where in theory market participants can lose 100% of credit extended to banks. In the swap market, however, losses can be no more than the difference in the net present value of the swap between the origination date and the default date.

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.
Kamakura’s rate forecast is available in electronic form, both in Kamakura Risk Manager table format and other forms, by subscription.

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