What The Term Premium Is And Is Not
The term premium is the additional yield investors demand for holding a long-duration bond rather than rolling a series of short-term instruments. It compensates for interest rate uncertainty, inflation uncertainty, supply-demand imbalances and liquidity risk over the life of the bond. It is not the expected path of short rates: that component is separately estimated as the expectations component of the yield.
The distinction matters enormously for positioning. When the 10-year UST yield is 4.35 percent and the short-rate path implied by Fed Funds futures puts the 10-year average short rate at 4.00 percent, the residual 35bp is the term premium estimate. If you believe short rates will average 3.80 percent over 10 years, the term premium is 55bp. The positioning implication depends on which component is responsible for yield changes.
The ACM model (Adrian, Crump and Moench), the Fed's preferred decomposition methodology, estimated the term premium at approximately 40 to 60bp through most of 2025, up significantly from the negative term premium regime that prevailed from 2012 to 2021. The desk's own model places the estimate slightly higher, at 55 to 75bp for the 10-year, based on a broader set of supply, inflation uncertainty and fiscal deficit inputs.
Historical Base Rates 1968 To 2024
The desk ran a historical decomposition of the US term premium from 1968 to 2024 using the ACM model extended backward. Five distinct regimes are identifiable.
1968-1980 (Rising inflation era): term premium rose from approximately 0bp to 300bp as inflation uncertainty became the dominant driver. The period demonstrated that persistent above-target inflation can drive term premium to levels that appear absurd in hindsight.
1981-1998 (Volcker disinflation and credibility building): term premium fell steadily from 300bp to approximately 80bp as the Fed's inflation-fighting credibility was established. The key insight: credibility building is a multi-decade process that suppresses term premium progressively.
1999-2007 (The Greenspan conundrum): despite global growth and rising short rates, the 10-year term premium fell to near-zero. The global savings glut, particularly from Asian central banks recycling current account surpluses into US Treasuries, created structural demand that compressed term premium independently of inflation dynamics.
2008-2021 (Zero lower bound and QE era): term premium went negative for extended periods. Quantitative easing effectively subsidised long-duration bonds, pushing term premium below the risk-neutral level.
2022-present (QT and fiscal expansion): term premium has risen sharply from the negative territory of the QE era. The combination of Fed balance sheet reduction, growing Treasury issuance from fiscal deficits and elevated inflation uncertainty has pushed the ACM term premium to 40 to 75bp.
Current Drivers Of Term Premium Elevation
The desk's view is that the post-2022 term premium elevation is structural rather than cyclical, driven by three factors that are unlikely to reverse quickly.
First, fiscal supply. The US government is running deficits of 5 to 6 percent of GDP with no credible path to reduction. This requires sustained net issuance of Treasury bonds at historically high levels. All else equal, more supply requires a higher price (lower yield) inducement, which manifests as a higher term premium.
Second, QE reversal. The Fed's balance sheet peaked at approximately USD 9 trillion in mid-2022. QT has reduced it to approximately USD 7.0 to 7.2 trillion by early 2026 and the pace is expected to continue. Each USD 1 trillion reduction in the Fed balance sheet removes structural demand for Treasuries, putting the term premium pressure in the same direction as fiscal supply expansion.
Third, inflation uncertainty. The post-2022 inflation experience demonstrated that inflation can re-emerge from a long dormancy with surprising speed. Even as current inflation has moderated, the uncertainty about the inflation process over a 10-year horizon is higher than it was in 2015 to 2019. Investors demand more compensation for that uncertainty.
The Reset Mechanics
The desk's base case for the steady-state term premium in the current regime is 60 to 90bp, compared to the 0 to 30bp range that characterised the 2012 to 2021 QE era. This implies a structural floor for the 10-year UST yield that is higher than the pre-2022 era, even after the FOMC completes its normalisation to a neutral short rate.
A simple illustration: if the FOMC cuts to a 3.50 percent terminal rate (our base case for end-2027) and the term premium stabilises at 70bp, the 10-year UST equilibrium yield is approximately 3.50 percent plus 0.70 percent plus a small convexity adjustment, implying a 4.20 to 4.30 percent long-run equilibrium. That is meaningfully higher than the 2.00 to 3.00 percent range that prevailed in the QE era.
The investor implication: structural long-duration positioning is a lower-return proposition in the post-QE era than in the 2010s. The case for duration is tactical (entering at peak yields with a view to a specific repricing catalyst) rather than structural (buy and hold for the carry and capital appreciation that worked from 2012 to 2021).
Positioning
The desk's duration positioning framework for the current environment: prefer intermediate (5 to 7 year) over long (15 to 30 year) maturity, because the term premium premium for extending from 7 to 30 years (currently approximately 40 to 50bp) does not adequately compensate for the fiscal supply and inflation uncertainty risks at the long end.
Tactical duration extension is warranted when: the 10-year UST yield is above 4.50 percent (implying term premium in excess of 80bp by most models) and the FOMC is in an active easing cycle. Structural long-duration is not warranted at current yield levels.