The 10-year Treasury yield looks high relative to CapitalSpectator.com’s fair value modeling. But after yesterday’s news that US consumer inflation fell more than expected in June, the relatively wide gap will likely narrow in the coming months.
The 10-year yield closed at 3.86% yesterday (July 12), which is close to its recent high.
Our fair value model, which reflects the average estimate of three models (defined here), indicates a rate of 2.90%, well below the current market rate. Today’s fair value estimate for June (based on the average of monthly data) marks a slight decrease from the previous estimate.
There can be no assurance that the market rate will soon, if ever, match the fair value estimate. But history shows that the current spread is relatively large, implying that over time the market rate will fall, the fair value estimate will rise, or a combination of both. In the meantime, the spread reflects a market rate well above the fair value estimate of approximately 85 basis points.
One of the reasons to believe that the market’s downward revision of the 10-year rate will do the heavy lifting to close the gap: new signs that US inflation continues to slow, reducing pressures to the rise in interest rates.
Consumer price index fell in June to lowest increase in more than two years, Labor Department says reports. “After a painful period of high inflation which eroded consumers’ purchasing power, the fever has subsided”, said Bill Adams, chief economist at Comerica Bank.
The continued deceleration in inflation convinces Johns Hopkins University economist Steve Hanke to predict that “the story of inflation is history.” He says CNBC: “One of the reasons for this is that the money supply has contracted year over year by minus 4% in the United States. We haven’t seen this since 1938. Changes in the money supply lead to changes in the price index and inflation.
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