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EDHEC-Risk Institute: Risk Premia Still Negative - Is A Recession Priced In The Curve?

Date 31/01/2019

EDHEC-Risk Institute has launched the EDHEC Bond Risk Premium Monitor in September 2017. Its purpose is to offer to the investment and academic communities a tool to quantify and analyse the risk premium associated with Government bonds (with an initial focus on US Treasuries).

  • The compensation for taking yield curve risk has slightly moved down again, and is well in negative territory for all maturities between 3 and 10 years. The reason is simple: the market yields are now below the expected path of the short rate (the “blue dots”), despite the very subdued projections of the Fed, which have never been lower, and which now even seem to imply a rate cut in the medium future.
  • Much has investors have been fretting about the possibility of a recession being priced in the shape of the yield curve, the most striking observation is by how much the Fed has lowered its expectations for the long-term target of the Fed fund rate, with the median last blue dot now below 3%. With an inflation target between 2% and 2.5% this implies a long-term projection of virtually zero real growth.
  • Why are market yields below the path of the blue dots? There can be two explanations: either the market expectations differ from the projections of the Fed; or there is a negative risk premium (as our model captures). A negative compensation for taking risk is compatible with Treasuries being perceived as a portfolio hedge to equity risk. The recent equity market turbulence makes the desire for equity protection topical.
  • In sum: Very low real long-term growth implied by the yield curve. Perhaps a recession in the medium term priced in the path of the blue dots and the shape of the yield curve. Risk premia small and negative, consistent with Treasuries being perceived as “equity insurance”. What rests to be seen is whether, when push comes to shove, after the “Greenspan/Bernanke/Yellen put” we will see the Powell put. Politics says that we will; monetary considerations make us more cautious.

Latest term premia estimates of the EDHEC Bond Risk Premium Monitor 

Highlights history from June 2017