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The market premium for the 10-year Treasury yield continues to trade at a narrow gap over a “fair value” estimate, based on the average estimate for three models run by CapitalSpectator.com.
The updated estimate indicates that the 10-year yield traded roughly 18 basis points above fair value in November, based on analytics using monthly data. The current estimate is close to the lowest market premium since April 2023.
The slide marks the reversal of the previous surge in the market premium in recent years and highlights that valuation trends on this front remain cyclical. Although the duration of the cycle varies and, to some extent, is random, it’s clear that the ebb and flow of the premium and discount to fair value is a hardy perennial.
The previous peak was in October 2023, when the 10-year yield traded at a 1.37 percentage-point premium over the market rate. At the time, I wrote:
“The spread is now at the 95th percentile, based on history since 1980. That implies that we’re near the peak.”
Echoing the historical record, the premium has faded recently. If the track record over the decades is a guide, there are non-zero odds that a negative premium will arrive at some point, although timing, as always, is uncertain.
Although short-term trading strategies based on the fair-value estimates aren’t recommended, the analytics can be used as the basis for tilting a bond portfolio one way or another for medium time horizons or longer. Generally speaking, when the fair value premium is relatively high (low), that implies that the 10-year yield will trend lower (higher).