In light of the interest-rate-risk-driven failure of Silicon Valley Bank on March 10, 2023, we have added a table that applies equally well to bank or institutional interest rate mismatches or individual mismatches from buying long-term Treasury bonds on margin. Calculating the Default Risk from Interest Rate Maturity Mismatches The probability of negative rates starts near zero but spikes, declines, and then rises steadily to peak at 5.1%, compared to 5.7% one week earlier, in the period ending February 2, 2029: The next graph describes the probability of negative 3-month Treasury bill rates for all but the first 3 months of the next 3 decades. Negative Treasury Bill Yields: 5.1% Probability by February 2, 2029 The next graph shows that the probability of an inverted yield remains high, peaking at 72.4%, compared to 66.9% one week before, in the 91-day quarterly period ending November 10, 2023. We measure the probability that the 10-year par coupon Treasury yield is lower than the 2-year par coupon Treasury for every scenario in each of the first 80 quarterly periods in the simulation. A recent example is this paper by Alex Domash and Lawrence H. Treasury yield curve is an important indicator of future recessions. Inverted Treasury Yields: Inverted Now, 72.4% Probability by November 10, 2023Ī large number of economists have concluded that a downward-sloping U.S. The next three sections summarize our conclusions from that simulation. Treasury yield curve out to thirty years. Using the methodology outlined in the appendix, we simulate 500,000 future paths for the U.S. Rates finally peak again at 4.80%, compared to 4.83% last week, and then decline to a lower plateau at the end of the 30-year horizon. After the initial rise, there is substantial volatility and rates peak again at 3.44%, compared to 3.50% one week ago. Using a maximum smoothness forward rate approach, Friday's implied forward rate curve shows a quick rise in 1-month rates to an initial peak of 5.79%, versus 5.59% last week. Treasury yield curve and the interest rate swap quotations based on the Secured Overnight Financing Rate published daily by the Federal Reserve Bank of New York. In this week's forecast, the focus is on three elements of interest rate behavior: the future probability of the recession-predicting inverted yield curve, the probability of negative rates, and the probability distribution of U.S. Treasury market since the 2-year Treasury yield was first reported on June 1, 1976: The table below shows that the current streak of inverted yield curves is the fourth longest in the U.S. The negative 2-year/10-year Treasury spread has now persisted for 215 trading days, currently at a negative 52 basis points, compared to negative 48 last week. Inverted Yields, Negative Rates, and U.S. Treasury yields through March 31, 2023, given in the appendix. The graph also shows a sharp downward shift in yields in the first few years, as explained below.įor more on this topic, see the analysis of U.S. The risk premium, the reward for a long-term investment, is large but narrowing over the full maturity range to 30 years. We document the size of that risk premium in this graph, which shows the zero-coupon yield curve implied by current Treasury prices compared with the annualized compounded yield on 3-month Treasury bills that market participants would expect based on the daily movement of Treasury yields since 1962. Robert Jarrow's book cited below, forward rates contain a risk premium above and beyond the market's expectations for the 1-month forward rate. The probability that the inverted yield curve ends by November 10, 2023, is now 27.6% compared to 33.1% last week. Both implied forward Treasury 1-month bill rates and simulated 3-month bill rates show a sharp drop in the near term, especially in the second semi-annual period.
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