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The market premium for the US 10-year Treasury yield continues to trade near a fair value estimate, based on the average estimate of three models run by CapitalSpectator.com. Today’s update shows an ongoing extension of the near-neutral level for the benchmark rate in recent months, following several years of a high market premium.
The current estimate indicates that the 10-year yield traded roughly 22 basis points over fair value in December, based on analytics using monthly data. That’s close to the lowest market premium in three years.
The recent shift toward a neutral level continues to highlight the reversal of the previous sharp rise in the market premium during 2022-2024. The recent drop from the previous peak reminds that valuation for the 10-year yield remains cyclical, albeit on an irregular and difficult-to-forecast timing basis.
Despite the seemingly random fluctuations in the market premium/discount through time, history suggests that the cycle revolves around zero (neutral). In turn, this dynamic provides an implied forecast for managing exposure to maturity risk for a bond-market strategy.
The current reading, which reflects a slight premium, implies a recommendation to adopt a more or less neutral stance for maturity risk vis-à-vis the 10-year yield.
By contrast, a higher allocation to maturity risk looked timely in late-2023, when the market premium was relatively high – above 120 basis points at the peak. Since then, the 10-year yield has fallen and the bond market has rallied.
There’s no guarantee that the cycle will continue to repeat, although it does appear to rhyme. Betting otherwise still looks like an excessively risky assumption.