OFR_2016_Financial-Stability-Report

Figure 8. Ten-Year U.S. Treasury Yield and Term
Premium (percent)
Long-term U.S. interest rates fell to historic lows, driving
term premiums below zero as the Federal Reserve raised
short-term rates
10
8
6
4
2
0
Yield
Term premium
December 2015
Fed “liftoff”
-2
1990 1995 2000 2005 2010 2015
Note: Data as of Oct. 31, 2016. Term premium is the excess yield
an investor must receive to purchase a longer-maturity bond over
a series of shorter-maturity bonds of the same issuer.
Source: Bloomberg Finance L.P.
Figure 9. U.S. Treasury 10-Year, 10-Year Forward
Rate (percent)
Forward rates have followed a consistent downward
trend since the 1980s
16
14
12
10
8
6
4
2
0
1972 1976 1980 1984 1988 1992 1996 2000 2004 2008 2012 2016
Note: Data as of Nov. 15, 2016. The 10-year, 10-year forward rate
is the interest rate investors expect on 10-year Treasury securities
in 10 years.
Sources: Bloomberg Finance L.P., OFR analysis
Valuations are high in some key asset classes. U.S.
equity valuations remain high based on metrics discussed
in a 2015 OFR Brief (see Berg, 2015). The cyclically
adjusted price-to-earnings ratio has only reached its current
level prior to the three largest equity market declines
in the last century (see Figure 10). Commercial real estate
prices have also climbed, and capitalization rates, one
measure of the return expected on a property, are close
to record lows. A price shock in one of these markets
could threaten U.S. financial stability if the assets were
widely held by entities that use high levels of leverage and
short-term funding. A price shock that coincided with a
sharp increase in U.S. corporate defaults would amplify
the risks, as discussed in Section 2.2.
Given the low level of interest rates, duration in U.S.
bond portfolios is near the top of its long-term range (see
Figure 11). This leaves investors open to heavy losses
from even moderate increases in interest rates.
Low long-term rates may stimulate the economy,
but they may also threaten the stability of financial institutions.
While interest rates have been falling for some
Figure 10. The CAPE Ratio
The cyclically adjusted price-to-earnings ratio (CAPE) is at
levels that have preceded sharp equity price declines
50
40
30
20
10
Average
0
1881 1897 1914 1931 1947 1964 1981 1997 2016
Note: CAPE is the ratio of the monthly S&P 500 index price level
to trailing 10-year average earnings (inflation adjusted).
Sources: Haver Analytics; Robert J. Shiller, Yale University, computed
with data from Standard & Poor’s, Federal Reserve, and U.S. Bureau of
Labor Statistics; OFR analysis
Financial Stability Assessment 11