Ben Laidler, global markets strategist at the eToro trading and investment platform. On this occasion, the expert addresses the return of the first term "as supply and demand increase in the fixed income market and doubts about the intervention of the Federal Reserve." “This may keep 10-year bond yields firmer than the bulls would like.”
The term premium is driving up bond yields. Ben Laidler, Global Markets Strategist at eToro
10 YEARS:
The 10-year US bond yield is one of the pillars of modern finance, influencing everything from housing to public finances to stock market valuations.
We have seen a spectacular round trip of these returns, from less than 4% to 5% and back in a year. In many respects, the volatility of bonds has been greater than that of equities.
The driver of this phenomenon has been the return of the so-called term premium in bond yields (see chart).
This premium has been dormant for a decade, but may be returning now, as supply and demand in the fixed income market and questions about Federal Reserve intervention increase.
This may keep 10-year bond yields firmer than the bulls would like.
COMPONENTS:
The 10-year bond yield has three main components.
1) The prospects for long-term real GDP growth,
2) long-term inflation expectations
3) the term premium that represents the "unobservable" differences between the first two components and the bond yield.
We approximate GDP with the New York Federal Reserve's GDP trend growth model of 2.2%. This could be a bit lower if we use the Fed's "dot plot" long-term GDP outlook of 1.8%.
Next, we use a 10-year breakeven inflation of 2.3%, which is also similar to 5-year expectations. This leaves us between 4.0% and 4.5%, not far from market levels. But it does not include the "term premium," which has caused most of the recent volatility.
PREMIUM PER TERM:
The term "premium" encompasses all the other risks involved in holding a bond long term. Over the past decade, this premium has been negative and capped returns.
But this has been the historical exception, as bonuses were the norm for the previous 30 years. And this has changed recently, driving yield volatility, possibly due to supply and demand concerns as the US deficit remains large and some foreign buyers look to diversify.
The move could also be due to the prospect of less Fed interference, be it QE or the more recent QT, or simply a catch-all for other bond tail risks.
Source: Territorioblockchain.com
