Weekly Treasury Simulation, March 7, 2025: Long-Run 1-Month Forward Rates Up 0.22%

2025-03-10 21:01:14 ET

Summary

• Treasury yields have shifted, with the 2-year yield at 3.99% and the 10-year yield at 4.32%, widening the 2-year/10-year spread to 0.33%.
• The probability of an inverted yield curve peaks at 24.2% by February 20, 2037, indicating potential recession signals.
• The risk premium for long-term investments is significant, with forward rates peaking at 5.30% and stabilizing at 4.15% over 30 years.
• Default risk analysis highlights a 46.61% probability of failure for a 10-year Treasury bond with a 5% equity ratio, emphasizing interest rate risk.

Summary

• Treasury 2-year yields remained at 3.99% this week, the same as last week. At 10 years, this week’s yield is 4.32%, compared with 4.24% last week.
• As a result, the current 2-year/10-year Treasury spread is now 0.33% compared to 0.25% last week.
• The maximum probability that the 2-year/10-year Treasury spread is negative again in the coming ten years is 24.2% in the 91-day period ending February 20, 2037, compared to 23.9% last week.
• The long-term peak in 1-month forward Treasuries is now 5.30% and well above the shortest maturity forward rate at 4.38%. The longest maturity 1-month forward rate is now 4.15% versus 3.93% last week.

As explained in Prof. Robert Jarrow’s book cited below, forward rates contain a risk premium above and beyond the market’s expectations for the 3-month forward rate. 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 government bond yields in 14 countries since 1962. The risk premium, the reward for a long-term investment, is large and widens over the full 30-year maturity range. The graph also shows a decline at a steady pace for the full 30 years. We explain the details below....

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