Understanding Term Premium in Fixed Income

Understanding Term Premium in Fixed Income

Stephen H. Dover, the Chief Market Strategist of Franklin Templeton, shared his thoughts on the rise in bond yields, and whether it should be feared. Higher yields do push up borrowing costs for corporations and households. 

 

And as long as yields stay elevated, global growth will be lower, profit expectations are squeezed, and there is greater risk to equities and credit markets. However, Dover attributes most of the increase in yields to rising term premiums rather than inflation or increased supply.

 

Term premiums are the additional yield that investors demand to hold onto longer-duration securities. Long-term rates are composed of 3 factors - inflation expectations, the neutral short-term interest rate path, and term premium. 

 

Since mid-July, the yield on the 10-year has advanced by more than 100 basis points. In contrast, the yield on the 2-year note is only up about 35 basis points over the same period. Notably, inflation expectations have moderated during that time frame as well, indicating that term premiums are to explain the surge in long-term yields. 

 

A major reason for the rise in term premiums is the removal of the ‘Fed put’ of the past decade, when central bank intervention was a constant through asset purchases and forward guidance. Overall, increased risk and volatility for long-duration bonds mean that investors need to be paid higher yields. 


Finsum: JPMorgan shared its Q4 fixed income outlook. Its two base-case scenarios are a recession and a period of below-trend growth. 

 

  • bonds
  • fed
  • fixed income

    The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

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