Term Premium
The extra yield investors demand for holding a long-term bond instead of rolling over short-term bonds — compensation for the additional uncertainty about future interest rates, inflation, and supply.
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What Is the Term Premium?
The term premium is the additional return investors require for accepting the extra risk of holding long-duration bonds rather than rolling over short-term bills. It exists because holding a 10-year bond exposes you to 10 years of uncertainty about inflation, interest rates, and economic conditions — risks that don't exist when holding 3-month T-bills.
Formally: Term premium = 10-year yield minus the expected path of short-term rates over the next 10 years.
Why the Term Premium Matters
Most of the time, when 10-year yields change, some of that change reflects changing expectations of the Fed's rate path, and some reflects changing term premium. Separating the two matters for:
- Equity valuations: High yields driven by term premium are less damaging to stocks than high yields driven by rate expectations (which signal tight monetary policy)
- Mortgage rates: Driven more by 10-year term premium than by Fed funds rate
- Risk sentiment: When term premium rises, it often reflects supply concerns or inflation uncertainty
Post-GFC Collapse
From 2009 to 2020, the term premium as estimated by the NY Fed's ACM model (Adrian, Crump, Moench) was near zero or negative. This was attributed to:
- QE suppressing long-end yields
- Global safe-asset demand
- Muted inflation and inflation volatility
Post-2022 Rise
The term premium began rising in 2022–2023 as:
- The Fed shifted from buyer to non-buyer (QT)
- US fiscal deficits ballooned, increasing Treasury supply
- Inflation uncertainty returned
By late 2023, the ACM term premium rose above 50bps for the first time in years — a key driver of the 10-year yield exceeding 5%.
How to Track It
The NY Fed publishes daily ACM term premium estimates at https://www.newyorkfed.org/research/data_indicators/term-premia-on-us-treasury-securities.
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