The year 2024 has witnessed a significant spike in the yield of 10-year U.STreasury bonds, which has surged beyond 4.7%, a new high since 2024. This increase has raised various discussions among economists and investors alike, particularly regarding the underlying factors influencing this trendOne of the primary contributors to the rise in yields seems to be the concept of term premium, as well as the associated risks posed by economic policies.
To understand the term premium, it's essential to note that it plays a pivotal role in the prevailing Treasury yield dynamicsThe nominal yield on U.S. 10-year Treasury bonds is essentially the aggregation of three components: the expected short-term real interest rates, anticipated inflation, and the term premium itselfThe term premium serves as a reflection of risk—the extra compensation investors demand for holding long-term bonds, which inherently carry heightened risks associated with yield and inflation volatility compared to short-term securities.
The current yield hike has veered away from the traditional patterns witnessed during previous Federal Reserve rate-cutting cycles
Notably, the surge appears to be discordant with movements in crude oil prices and economic surprise indices, suggesting that explanations relying solely on inflation expectations or sustained economic resilience may be inadequateInstead, stakeholders are confronted with additional layers of risk, including geopolitical uncertainties and fluctuating fiscal policies.
In recent months, the term premium has emerged as the main catalyst driving the uptrend in Treasury yields, particularly since December 2024. A breakdown of the contributing factors reveals that the climbing term premium has outstripped upward revisions to inflation expectations and diminished expectations for rate cutsWhen investors perceive an increase in uncertainty surrounding economic and policy factors, it tends to raise the term premiumInvestors feeling more exposed to holding long-term Treasury securities call for higher returns, which propels the term premium further up.
Notably, the nature of the players in the Treasury market is also evolving
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The market has seen a rising prevalence of price-sensitive investors, which includes private sector participants such as hedge funds and mutual funds that are not categorized as Federal Reserve, insurance companies, pension funds, or foreign official institutionsThese players are highly responsive to changes in bond yields and generally require a more significant risk premium, putting additional pressure on the term premium, especially as foreign demand for Treasuries has continued to diminish since 2008.
Moreover, during the pandemic, we witnessed a substantial decrease in Treasury supply due to quantitative easing measures employed by the Federal ReserveHowever, since the pandemic has unfolded, the risks associated with treasury supply have started to emergeFor instance, during the latter half of 2023, supply shocks significantly contributed to the rise in U.STreasury yieldsFollowing the resolution of the debt ceiling crisis in June 2023, the Treasury Department rapidly issued new bonds to bolster cash reserves, which led to short-term pressures on Treasury supply and transformed the landscape of term premiums.
The pressing question remains: how sustainable is the rise in term premium? Current uncertainties in the U.S. economy regarding inflation, interest rates, and varied economic policies continue to persist, leading to an environment where the term premium may remain elevated
Since Q4 2024, uncertainties around fiscal, monetary, and trade policies have risen markedly, with the greatest increase occurring in the trade policy arenaAmbiguities surrounding newly proposed governmental policies and their operational framework have amplified investors' concerns regarding future economic stability and inflation trajectories.
In this tumultuous climate, the demand from foreign officials and the Federal Reserve for U.STreasuries remains subdued, while the proportion of price-sensitive investors might continue to climbWith foreign purchasing of U.S. debt still on the decline and ample reserves at the Federal Reserve’s disposal, the implications for liquidity and bond issuance are uncertainSince 2020, high inflation has reshaped the correlation between equities and bonds, complicating the risk-hedging capabilities of bonds and possibly causing pension funds and insurance companies to reassess their Treasury investment strategies.
Additionally, at a macro level, the impending wave of maturing mid-to-long-term Treasury bonds presents complexities for future supply
With the U.S. government sustaining high deficits, Treasury issuance may be expected to remain elevatedThe normalization of the Treasury's net issuance structure, which has previously skewed towards short-term instruments, suggests a return to a predominance of mid-to-long-term securities, maintaining a steady supply in the marketShould the debt ceiling debate drag on longer than anticipated, the culmination of mid-to-long-term debt may confer new supply shocks into the market.
In terms of immediate market sentiment, the confluence of policy uncertainties and economic resilience signals that Treasury yields might remain at elevated levelsHowever, as forthcoming policies materialize, we could possibly witness a gradual easing of the prevailing uncertainties, which may ultimately result in a downward correction in yieldsShould tariff measures implemented by the government translate into observable economic data reflecting a slowdown, this could act as an important force nudging Treasury yields lower.
In conclusion, while the dynamics of the 10-year U.S
