How Rising Rates and US Debt Brought Back Term Premiums

Bond investors regained a perk in September that they hadn’t had in years: They’re getting paid extra to lend money to the US government for longer periods. This so-called term premium for 10-year Treasury notes turned positive at the end of the third quarter, reflecting in part investors’ expectations of an extended period of higher interest rates — and their uncertainty over how long the Federal Reserve will keep them high — as well as an onslaught of debt issuance as the government finances a growing budget deficit.

It’s one of three contributors to a bond’s yield. (The other two are market expectations for interest rates and inflation.) Some market experts define term premium as the compensation a bond investor demands for taking the risk that market forces like interest rates might change over the life of a bond. Put another way, it’s the difference between the yield compensation investors require for locking up their money for an extended period relative to what they would get by rolling over short-term instruments for the same amount of time. The tricky thing about a term premium is that it’s “not directly observable,” as the Federal Reserve of New York puts it. It can only be estimated.