The shadow hanging over the global market comes from this mysterious "professional term"

Strong non-farm payrolls trigger a surge in U.S. Treasury yields, casting a shadow over global assets, and this wave of increase is primarily driven by "term premium." So, what is the term premium "rising" for?

Specifically, U.S. Treasury yields are mainly composed of three key components: short-term real interest rate expectations, inflation expectations, and term premium. Analysts generally believe that the term premium is the main reason for the recent rise in U.S. Treasury yields.

After the strong employment report was released on Friday, the New York Fed's term premium indicator climbed to its highest level in at least a decade.

Furthermore, the current rise in term premium is attributed to the uncertainty surrounding Trump’s policies and the supply-demand imbalance in U.S. Treasuries, as the peak maturity of U.S. medium- and long-term government bonds is approaching in 2025.

Looking ahead, Shenwan Hongyuan stated that the uncertainty in the U.S. economy and policies during the early days of Trump's administration may support high volatility in interest rates. China International Capital Corporation (CICC) pointed out that the current steepening of the U.S. Treasury yield curve is consistent with characteristics seen at the end of a rate-cutting cycle.

What is term premium? What is the term premium "rising" for?

Term premium refers to the inherent risk of holding a U.S. Treasury bond with a maturity of 10 years instead of 1 year or 5 years, primarily measuring unexpected risks. It can be divided into inflation risk premium and real risk premium, with the latter mainly including uncertainties related to interest rates, policies, and deficits.

In this regard, Nomura Securities believes that term premium is actually a "universal explanation." Nomura analyst Charlie McElligott stated that term premium is a concept that is difficult to measure accurately and is often used to explain bond market fluctuations that cannot be accounted for by other factors.

Specifically, Shenwan Hongyuan identified three major factors affecting term premium:

1. Increased economic and policy uncertainty: Term premium is positively correlated with economic uncertainty. When investors expect higher risks associated with holding long-term government bonds, the required rate of return also increases, driving up term premium. The financial environment post-2010 once pushed term premium below zero, but since 2021, the MOVE index reflecting uncertainty has significantly increased again.

2. Increased proportion of price-sensitive investors in the U.S. Treasury market: Price-sensitive investors refer to private sector participants in the Treasury market, excluding the Federal Reserve, insurance companies, pension funds, and foreign official institutions. After 2008, the demand for bond purchases from foreign officials continued to decline; in 2022, the Federal Reserve shifted to balance sheet reduction, jointly driving up the proportion of price-sensitive investors, which may push term premium higher.

3. Increased supply of U.S. Treasuries: Before the pandemic, the pressure on the supply side of U.S. Treasuries was low, especially during quantitative easing (QE), where the Federal Reserve's bond purchases reduced market supply risks. However, post-pandemic, in a low unemployment environment, excessive expansion of deficits has increased supply-side pressure. A typical case is the concentrated issuance of U.S. Treasuries in the third quarter of 2023, which triggered an increase in term premium and interest rates.

CICC also believes that the term premium, rather than interest rate expectations, is the main contributor, indicating that short-term bond issuance supply is the primary driver, rather than hawkish monetary policy:

The significant rise in term premium reflects an increased demand for holding risk compensation due to short-term supply disruptions. Firstly, the U.S. Treasury expects that the bond issuance scale in the first quarter of 2025 may reach USD 823 billion, the second highest since the unexpected bond issuance in 2Q23. Secondly, due to many of Trump's policies being more fiscally expansive, as the inauguration approaches, the market is concerned about the future sustainability of debt and the potentially high long-term bond issuance. Finally, the term premium also reflects the risk compensation for holding long-term government bonds. The uncertainty in the Federal Reserve's policy path is increasing, thus investors may require greater risk compensation to hedge.

What’s next? Will interest rate hikes return?

Looking ahead, Shenwan Macro believes that there is upward pressure on the term premium:

In the early days of Trump's presidency, the uncertainty of the U.S. economy and policies may support high volatility in interest rates. The policy signals released by the Trump administration are relatively vague, and the uncertainty surrounding U.S. monetary, fiscal, and trade policies has increased. After the president's inauguration, as policies gradually take effect, the risk of uncertainty may ease to some extent, but referring to the 1.0 period, the risks of the economy and policies during Trump's term may still be high.

The contradiction between supply and demand for government bonds remains a concern. The demand for bond purchases from overseas officials, the Federal Reserve, and other institutions is still difficult to recover. The high inflation environment has led to a positive correlation between U.S. stocks and bonds, reducing the risk hedging ability of bonds, further weakening the demand from institutions such as pensions and insurance. In 2025, the U.S. medium- and long-term government bonds will face a peak of maturity, and the high deficit fiscal outlook may keep government bond supply at a high level.

However, during the policy implementation process, as the "shoe" drops, high interest rates that deviate from the fundamentals are difficult to sustain. After the tariff policy takes effect, the weakening of economic data may also become an important force driving U.S. Treasury yields downward.

From the perspective of the yield curve shape, CICC indicates that the yield curve is bear steepening, consistent with the characteristics at the end of a rate cut cycle:

Recently, long-term U.S. Treasury rates have risen faster, with the 2s10s spread turning positive at 38 basis points, showing a bear steepening trend. Generally, bear steepening of the yield curve occurs more often at the end of a rate cut cycle and the beginning of a rate hike cycle. Currently, the U.S. yield curve has completely turned positive, and since December 8, 2024, long-term U.S. Treasury rates have further increased, which is consistent with the pattern at the end of a rate hike cycle.

Nomura states that the curve will continue to steepen. Although the term premium has risen, the starting point is very low, and long-term bond buyers will continue to demand higher premiums to extend loan terms. Additionally, the Federal Reserve has a dovish response function, and if economic conditions deteriorate significantly, the trend is expected to ease rapidly Barclays mentioned concerns about interest rate hikes. Barclays analysts pointed out that since the Federal Reserve's rate cut in September, most of the sell-off has been driven by term premiums. The market is not only unconcerned about a hard landing but is also quite worried about the Federal Reserve raising interest rates, with this level of concern even exceeding that during the actual tightening of policies by the Federal Reserve in September 2023.

However, Goldman Sachs believes that the likelihood of interest rate hikes in the short term is low. Goldman Sachs Chief Strategist Josh Schiffrin stated that unless inflation rises significantly, the chances of the Federal Reserve raising interest rates in the short term are relatively low.

Risk Warning and Disclaimer

The market has risks, and investment requires caution. This article does not constitute personal investment advice and does not take into account the specific investment goals, financial situation, or needs of individual users. Users should consider whether any opinions, views, or conclusions in this article align with their specific circumstances. Investment based on this is at one's own risk