Investors Demand Higher Premiums for Long-Term Bonds

Investors are increasingly seeking higher compensation for the risk associated with purchasing longer-dated bonds instead of short-term debt. The term premiums on the 10-year U.S. Treasury note, which serves as a Federal Reserve measure for long-term market risk, have experienced a gradual increase in August. On Tuesday, it reached its highest level since November, rising to negative 0.1975%. According to Dow Jones Market Data, this represents a net change of 0.1463 percentage points, almost four times the average daily movement recorded over the past three decades.

The payout on a 10-year note is influenced by various factors, with the term premium playing a significant role. Essentially, the term premium acts as compensation or added yield that investors demand in order to hold a long-term bond rather than short-term debt. It reflects the potential impact of unexpected economic developments or changes in monetary policy that may affect the value of a bond or note. Longer-dated debt is more susceptible to these changes compared to shorter-term securities.

In the last two years, the term premium has consistently ended below zero, indicating that investors have not been demanding any additional compensation. However, this recent surge suggests a shift in investor sentiment as they require greater premiums for taking on the risks associated with long-term bonds.

Recent Shift in Perception of Lending to the U.S. Government

The recent rise in yields on longer-dated debt indicates a shift in perception about lending to the U.S. government. The premium, although still negative at -0.52% on Wednesday, has shown signs of change.

Rise in Yields on Longer-Dated Debt

On Monday, the yield on the 10-year note reached its highest point since late 2007 at 4.339%. This increase could be attributed to various factors.

Factors Behind the Rise

Investors may be factoring in a higher rate of inflation than previously anticipated, which contributes to the rising risk premium. Additionally, uncertainty surrounding the outlook for bond prices due to recent selling pressure is playing a role.

Impact of Japanese Investors

The Bank of Japan's recent shift in monetary policy has prompted Japanese investors, who are major foreign holders of U.S. government debt, to consider selling Treasurys and purchasing Japanese debt instead.

Term Premiums and Recessions

Researchers have found that term premiums tend to rise during recessions. In March 2020, the largest one-day increase in Treasury premiums since 2000 was observed.

Fitch Ratings Downgrade

The Fitch Ratings downgrade of the U.S. debt default rating to AA+ from AAA on August 1st has further added to the uncertainty. Although U.S. Treasurys remain the safest asset globally, this downgrade still holds significance.