The term premium is the extra yield investors demand to hold a long-dated bond instead of rolling short-dated instruments over the same horizon. It compensates for the risk that future short rates, inflation, or fiscal supply diverge from expectations, and is the residual in nominal yields once the expected-rates path is stripped out.
How it works
A nominal long yield decomposes into the average expected short rate over the bond's life plus the term premium. The premium is unobservable and model-estimated (e.g. ACM, Kim-Wright); it rises with uncertainty about the rate path, inflation, and the supply-demand balance for duration. The compensation for inflation uncertainty specifically is the inflation term premium.
Why it matters now
In the 2025-2026 steepening thesis, a politically pliable Fed cutting the front end while heavy Treasury issuance and fiscal-dominance fears push the long end is expected to widen the term premium — the curve bear-steepens not because growth recovers but because investors price more duration risk.
Example
The New York Fed's ACM model put the 10-year term premium deeply negative (around -100bp) through the QE era of the late 2010s. By late 2023, as the Treasury ramped coupon issuance and rate uncertainty spiked, ACM estimates pushed the 10-year term premium back into positive territory for the first time since 2021 — roughly a 100bp swing that lifted long yields independent of any change in the expected policy path.
Frequently asked
- What is the term premium?
- The term premium is the extra yield investors demand for holding a long-dated bond rather than rolling short-dated paper over the same horizon. It compensates for the risk that future short rates, inflation, or bond supply diverge from expectations. Because it cannot be observed directly, it is estimated as the residual in nominal yields once the expected-rates path is removed, using models like the NY Fed's ACM.
- How is the term premium estimated?
- The term premium is estimated by a no-arbitrage term-structure model that splits a nominal yield into an expected-short-rate path and a residual. The NY Fed's ACM model uses linear regressions on yield factors; the Fed Board's Kim-Wright model uses a latent-factor approach. Both are model-dependent, so estimates of the same 10-year premium can differ by tens of basis points
Glossary · 25bp / bp
A basis point (bp) is one-hundredth of a percentage point (0.01%); 25bp equals 0.25 percentage points, the conventional increment of a single central-bank rate move. Policymakers quote rate changes, yields, and spreads in basis points to avoid the ambiguity of percentage-of-a-percentage phrasing.
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- Why does the term premium matter for the curve in 2025-2026?
- The term premium matters because long yields can rise even when the Fed is cutting. In the 2025-2026 bear-steepening thesis, a pliable Fed easing the front end while heavy Treasury issuance and fiscal-dominance fears lift the long end widens the premium. The curve steepens on duration risk, not growth recovery, decoupling long yields from the expected policy path.
- How does the term premium differ from the expected-rates path?
- The term premium is the risk-compensation component of a yield, while the expected-rates path is the average short rate markets project over the bond's life. Together they sum to the nominal long yield. A 10-year yield can rise because markets expect more Fed hikes (path) or because investors demand more duration compensation (premium) — and the two have very different policy implications.
- Can the term premium be negative?
- Yes, the term premium can be negative, meaning investors accept less yield on a long bond than the expected average short rate would justify. NY Fed ACM estimates put the 10-year premium near -100bp through the mid-to-late 2010s, driven by QE, safe-asset demand, and low rate-path uncertainty. It turned positive again in late 2023 as Treasury supply surged.