‘Dark Matter’ Bond Metric Mesmerizes Wall Street and Washington

It’s the buzzword on Wall Street and in the hallways of the Federal Reserve and Treasury Department. It’s blamed for triggering bond selloffs, shifts in debt auctions and interest-rate policy. That few agree on what exactly it reflects, or how to measure it, seems to matter little — the term premium is a powerful new force in the market.

Typically described as the extra yield investors demand to own longer-term debt instead of rolling over shorter-term securities as they mature, the term premium, in the broadest sense, is seen as protection against unforeseen risks such as inflation and supply-demand shocks, encapsulating everything other than expectations for the path of near-term interest rates.

The problem is it’s not directly observable. Various Wall Street and central bank economists have developed models to estimate it, often with wildly conflicting results. The one thing that most market observers, including Federal Reserve Chair Jerome Powell, can agree on is that in recent months the term premium has soared, likely fueling the dramatic ascent in long-term rates that only recently has started to fade.

The implications for the trajectory of monetary policy are substantial. Powell and other Fed officials have said that the jump in the term premium could hasten the end of their interest-rate hikes by squeezing growth in the economy, effectively doing some of the work for them as they try to rein in inflation. Yet with traders having long struggled to handicap the Fed’s next moves, some warn the central bank’s focus on the notoriously hard-to-understand feature of the US government debt market is making it even more difficult to anticipate the path of rates going forward.

“It seems like a strange door for the Fed to open,” said Jason Williams, a global market strategist at Citigroup Inc. “It’s puzzling as the term premium is something that by definition you can’t know, which the Fed realizes but still is saying its rise is important and can offset some potential hikes.”

US Treasury Term Premium Surges