A Treasury term premium that isn't
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A TREASURY TERM PREMIUM THAT ISN'T
A shallower inversion of U.S. Treasury yield curve in recent days calls to mind the historically curious and related case of the Treasury term premium, which according New York Federal Reserve models indicates investors are not demanding extra compensation for taking greater risk to hold longer-term Treasury bonds, as theory would have it.
Term premium can be difficult to pin down precisely. It makes sense that investors should be paid more the further out on the curve they go because of the greater risk that interest rates may change. In the 1980s, the term premium was upwards of 500 basis points, but it has been mainly negative for the better part of a decade. The yield curve refers to real-time spreads between specific Treasury maturities, is more volatile and subject to the investor sentiment on Fed policy, the economy, Treasury issuance, etc.
The most widely watched yield curve differential currently has the two-year note yield about 28 basis points (bps) above the 10-year note's. Less than a month ago, it was more than 50 bps above. In a normal upward sloping yield curve, short-term interest rates would be lower than longer term rates. They could head in that direction once the Federal Reserve starts easing, which traders currently see happening in September.
Jack McIntyre, portfolio manager, global bonds, at Brandywine Global, said the yield curve should steepen more once the Fed pivots, but the degree could be less if it comes off as worried about the economy.
"Shorter rates are going to move more than the long end. You get the duration aspect. On a total return basis you get a bigger bang for your buck being further out the curve," he said.
According to the New York Fed, the ten-year Treasury term premium in June was negative 14.2 bps relative to a theoretical short term rate (like estimated average T-bill yields over that term.) The last time term premium was actually a premium was November 2023 and since the end of 2015 it has only been positive for three brief bouts, unlike 2s/10s, which inverted in 2022 as the Fed started to hike rates from zero to curb inflation.
This period has corresponded with a ballooning of Federal spending and deficits and this year the term premium has been a focus of attention by some fund managers, notably bond giant Pimco. The Treasury also ballooned supply during the pandemic, and the Fed was the biggest buyer under quantitative easing.
Nate Thooft, chief investment officer of multi-asset solutions at Manulife Investment Management, said he thinks that term premium is "pervasively underpriced" as you go out the yield curve, given the size of the debt, something the market must eventually account for.
"It's difficult to put a time on that. It's difficult to put a magnitude on that but that's another argument why we don't fully expect another parallel shift on the yield curve when the Fed starts its cutting cycle," he said.
U.S. debt/GDP has doubled over the last two decades, according to Nicholas Colas, co-founder of DataTrek Research, noting in a newsletter on Tuesday that the 10-year Treasury yield is about where it was 20 years ago. He wrote that persistent deficits have not changed inflation expectations or real interest rates.
"We read a lot of bearish commentary that says deficits will eventually spike yields higher, but there is simply no evidence this is happening yet," Colas wrote.
(Alden Bentley)
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Treasury Term Premium https://tmsnrt.rs/3Wowwzc
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