The Bond Market Is Charging Rent
The term premium has gone from a subsidy to a charge, and nobody agrees on what it means. That disagreement is the message.
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The Bond Market Is Charging Rent
The term premium has gone from a subsidy to a charge, and nobody agrees on what it means. That disagreement is the message.
MICHAEL A. GAYED, CFA
Key Highlights
- The FRBSF-estimated 10-year term premium stands at 1.33 as of Sep 10, up from 1.06 a year earlier.
- The New York Fed decomposition puts the premium near 0.89, and the two models have never fully agreed.
- The 10-year nominal yield at 4.97 cannot be explained by expected policy rates alone.
- Both estimates point the same direction even where they disagree on level: the era of negative risk compensation for duration is over.
The surface story is a 10-year Treasury yield near 5 percent. The real catalyst is what that yield is made of. The compensation for holding duration, the term premium, has flipped from a subsidy into a charge, and the market has not fully priced what that means for every asset valued off the long end.[1]
For most of the 2010s, owning the long bond was a trade that paid you twice. It paid the coupon, and it paid the hedge: whenever equities fell, Treasuries rallied, so duration reduced portfolio risk while collecting yield. That double payment rested on one invisible foundation, a negative or near-zero term premium, meaning investors required no extra compensation for bearing duration risk. Through the middle of the last decade the premium sat at levels that, in the Fed's own decompositions, implied investors were paying the government for the privilege of holding its longest paper. The 2019 dip briefly took the estimate negative outright. Duration was not just free. It was subsidized.
