Rate Inversion and Russian Invasion

04/01/2022 11:50 AM

Rate Inversion and Russian Invasion
Nonetheless the Kamakura Troubled Company Decreases by 1.67% to 5.32%
Credit Quality Improves to the 96th Percentile

NEW YORK, April 4, 2022: While the pundits argue about whether an inverted Treasury curve can predict recession based on only 4 past occurrences, there is no argument that the Russian invasion of Ukraine has put the world economy in uncharted territory.  Meanwhile, inflation triggered by massive covid-era government spending finally became such an obvious risk factor that even the Federal Reserve Board noticed.

The Kamakura Troubled Company Index® shows that, despite these ominous risk factors, short-term credit risk remains low and the longer run credit outlook continues to be worrisome. The index reversed course in March and indicates that credit conditions improved 8 points to the 96th percentile of the period from 1990 to the present.  The 100th percentile indicates the best credit conditions during that period. The Kamakura Troubled Company Index closed March at 5.32%, compared to 6.99% the month before. The index measures the percentage of 40,500 public firms worldwide with an annualized 1-month default probability over 1%. An increase in the index reflects declining credit quality, while a decrease reflects improving credit quality.

At the close of March, the percentage of companies with a default probability between 1% and 5% was 4.62%, a decrease of 1.29% from the previous month. The percentage with a default probability between 5% and 10% was 0.52%, a decrease of 0.26%. Those with a default probability between 10% and 20% amounted to 0.15% of the total, representing a decline of 0.09%; and those with a default probability of over 20% amounted to 0.03%, a fall of 0.03% over the prior month.

Figure 1: Troubled Company Index — March 31, 2022

Among the 20 riskiest-rated firms listed in March, 12 were in China (including Hong Kong) two in Great Britain, and one each was in the United States, Canada, Japan, Malaysia, Mexico, and Norway. The riskiest-rated firm was Zhangmen Education Inc. with a one-month KDP of 30.74%, down 7.55% from the previous month.  There were no defaults in the Kamakura coverage universe in March.

Table 1: Riskiest-Rated Companies Based on 1-Month KDP – March 31, 2022

The Kamakura Expected Cumulative Default Rate, the only daily index of credit quality of rated firms worldwide, shows the 1-year rate up 0.03% at 1.68% and the 10-year rate up 0.06% at 19.15%.

Figure 2: Expected Cumulative Default Rate — March 31, 2022

By Donald R. van Deventer, Founder, Kamakura Corporation

Fourteen U.S. dollar bonds from Russian issuers traded in the U.S. bond market on March 31.  Prices ranged from 8 to 68 for the day. Prices were mixed as hedge funds arm-wrestled over their projections for the biggest armed conflict in Europe in 8 decades. Meanwhile, in domestic U.S. markets, pundits large and small tried to extract statistical significance from 4 (yes, only four) past incidences of inverted Treasury yields.  Kamakura’s projections done on March 25 showed a probability of the 2-year/10-year inversion of 50.9% at year-end 2022.  Meanwhile, on April 1, the two-year yield hit 2.44% with the 10-year 6 basis points lower at 2.38% according to the U.S. Treasury’s daily time series of constant maturity yields.

With inflation running rampant, why are U.S. Treasury yields on the long end of the curve still trading in the 3 percent range?  A recent study done by Kamakura reveals the surprising fact that rolling over short-term Treasuries has never been better than holding 10-year and longer U.S. Treasuries to maturity.  That study examined every single trading day since January 1982 through December 31, 2021.  Kamakura’s interest rate outlook also shows a hefty term premium over the best available estimates of expected short Treasury yields over the full 30-year maturity spectrum.  We leave it to the reader to opine on whether that happens because of more skillful management of the economy by the current set of government officials or because of a more skillful selection of government officials by the voters. In either case, skillful risk management is essential.

Lastly, on the occasion of Kamakura’s 32nd anniversary, the entire multinational team at Kamakura wishes to express our heartfelt thanks to our extremely sophisticated group of risk management clients.

Table 3: Russia U.S. Dollar Bonds – March 31, 2022

About the Troubled Company Index
The Kamakura Troubled Company Index® measures the percentage of 40,500 public firms in 76 countries that have an annualized one- month default risk of over one percent. The average index value since January 1990 is 14.26%.  Since November 2015, the Kamakura index has used the annualized one-month default probability produced by the KRIS version 6.0 Jarrow-Chava reduced form default probability model, a formula that bases default predictions on a sophisticated combination of financial ratios, stock price history, and macro-economic factors.

The KRIS version 6.0 models were developed using a data base of more than 2.2 million observations and more than 2,600 corporate failures. The forthcoming version of KRIS default probabilities uses more than 20 million observations and more than 7,000 corporate failures. A complete technical guide, including full model test results and parameters, is provided to subscribers. The KRIS service also includes a wide array of other default probability models that can be seamlessly loaded into Kamakura’s state-of-the-art enterprise risk management software engine, the Kamakura Risk Manager. Available models include the non-public-firm default model, the commercial real estate model, the U.S. bank model, and the sovereign model.  Related data includes credit default swap trading volume by reference name, market implied credit spreads, and prices on all traded corporate bonds traded in the U.S. market.  Macro factor parameter subscriptions include Heath, Jarrow, and Morton term structure models for government securities in the U.S., Germany, the UK, Canada, Spain, Sweden, Australia, Japan, Thailand, and Singapore.  All parameters are derived in a no-arbitrage manner consistent with seminal papers by Heath, Jarrow, and Morton, as well as Amin and Jarrow.  A KRIS Macro Factor Scenario Service subscription includes both risk neutral and “real world” empirical scenarios for interest rates and macro factors.

The version 6.0 model was estimated over the period from 1990 through the Great Financial Crisis and includes the insights of the entirety of that era. The 76 countries currently covered by the index are:  Argentina, Australia, Austria, Bahrain, Bangladesh, Belgium, Belize, Botswana, Brazil, Bulgaria, Canada, Chile, China, Colombia, Croatia, Cyprus, Czech Republic, Denmark, Egypt, Estonia, Finland, France, Germany, Ghana, Greece, Hungary, Hong Kong, Iceland, India, Indonesia, Ireland, Israel, Italy, Japan, Jordan, Kenya, Kuwait, Luxembourg, Malaysia, Malta, Mauritius, Mexico, Nigeria, the Netherlands, New Zealand, Norway, Oman, Pakistan, Peru, the Philippines, Poland, Portugal, Qatar, Romania, Russia, Saudi Arabia, Serbia, Singapore, Slovakia, Slovenia, South Africa, South Korea, Spain, Sri Lanka, Sweden, Switzerland, Tanzania, Taiwan, Thailand, Turkey, the United Arab Emirates, Uganda, the UK, the U.S., Vietnam and Zimbabwe.

About Kamakura Corporation
Founded in 1990, Honolulu-based Kamakura Corporation is a leading provider of risk management information, processing, and software. Kamakura was recognized as a category leader in the Chartis Report, Technology Solutions for Credit Risk 2.0 2018.  Kamakura was named to the World Finance 100 by the editor and readers of World Finance magazine in 2017, 2016 and 2012. In 2010, Kamakura was the only vendor to win two Credit Magazine innovation awards., Kamakura Risk Manager, first sold commercially in 1993 and now in version 10.1, is the first enterprise risk management system for users focused on credit risk, asset and liability management, market risk, stress testing, liquidity risk, counterparty credit risk, and capital allocation from a single software solution. The KRIS public firm default service was launched in 2002. The KRIS sovereign default service, the world’s first, was launched in 2008, and the KRIS non-public firm default service was offered beginning in 2011. Kamakura added its U.S. Bank default probability service in 2014.

Kamakura has served more than 330 clients with assets ranging in size from $1.5 billion to $7.0 trillion.  Current clients have a combined “total assets” or “assets under management” in excess of $38 trillion.  Its risk management products are currently used in 47 countries, including the United States, Canada, Germany, the Netherlands, France, Austria, Switzerland, the United Kingdom, Russia, Ukraine, South Africa, Australia, China, Hong Kong, India, Indonesia, Japan, Korea, Malaysia, Singapore, Sri Lanka, Taiwan, Thailand, Vietnam, and many other countries in Asia, Europe and the Middle East.

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