Cooler PCE Inflation Fails to Rescue Stocks as the 10-Year Yield Tops 5.3%

Term Premium

The term premium is the extra yield investors demand for holding a long-term bond instead of rolling over a series of short-term bonds. If the 10-year yield is 5.3% and the expected average of future short-term rates over those ten years is 4.5%, the term premium is the remaining 0.8 percentage point. It is compensation for risks that grow with time: unexpected inflation, uncertainty about future Fed policy, and the chance that bond prices fall before maturity. The term premium cannot be observed directly. Models such as the New York Fed's ACM model estimate it by splitting a Treasury yield into an expected-rate component and a premium component. Several forces push it higher: large government deficits that require more bond issuance, higher inflation uncertainty, and reduced demand from big buyers. It can also turn negative when investors prize long bonds as a hedge, as in many years after the 2008 crisis. Because the premium is independent of where the Fed sets its policy rate, long yields can rise even when the Fed is not tightening, and even when inflation data improves. A rising term premium raises borrowing costs across the economy, from mortgages to corporate debt, and lowers the present value of stocks, especially growth stocks whose profits lie far in the future.