There’s a theoretical construct in the world of fixed income that’s hard to quantify, but appears to be keeping long-dated yields on U.S. government debt higher for now.
It’s known as term premium, or the extra compensation that investors demand for the perceived risk of holding Treasury maturities over the long term. This term premium flipped to positive in recent weeks and has contributed to the rise in the 10-year rate since September, according to analysts.
“The term premium, which is unobservable and hence must be approximated, considers a variety of factors, including Treasury supply/demand dynamics, foreign central-bank expectations, and the possibility of future inflationary pressures. Additionally, rising term premiums could also indicate markets are betting on higher government deficits depending on election odds,” said Lawrence Gillum, chief fixed-income strategist for broker-dealer LPL Financial.
“A positive term premium could keep longer-term interest rates elevated, perhaps reducing the diversification benefits of core bonds,” Gillum wrote in an online post on Tuesday. He added that “while we still believe Treasury securities will be the safe-haven choice in the case of a broad macro equity-market selloff, they may not be the best defensive option for garden-variety equity market selloffs.”
