The term premium for bonds is the excess return for holding a long bond over a series of short rates. Long-term rates should be equal to the combination of future short rates, but the relationship is not perfect. There is a term premium with bonds which is the difference between actual yields and the average of the short rates of yields. The term premium could be the risk from holding long-term securities or related to the change in the demand for long-term securities. Hence, the number could be positive or negative for which the answer is an empirical question that may change through time.
From a macroeconomic perspective, the term premium is the portion that cannot be explained by real and expected inflation, or the combination of risk premiums on real rates and expected inflation. It sounds so easy to find this value; however, it actually takes some work. It can be calculated through splicing together forwards, forming an econometric model of macro factors, or through a comparison with survey forecasts and actual bond yields.
From a macroeconomic perspective, the term premium is the portion that cannot be explained by real and expected inflation, or the combination of risk premiums on real rates and expected inflation. It sounds so easy to find this value; however, it actually takes some work. It can be calculated through splicing together forwards, forming an econometric model of macro factors, or through a comparison with survey forecasts and actual bond yields.
Analysts have been spending more time calculating this term premium number because it is critically important to help find the equilibrium interest rate. If we know what is the risk premium and the equilibrium rate, we will have a better idea of whether current rates are loose or tight relative to some valuation. Of course, finding each of these is subject to error and not directly observable.
The term premium seems to be counter-cyclical and thus rising when output is low. Still what is worrying to many is the long-term downtrend in the term premium. It has turned negative until recently which, while not unprecedented, has not occurred for decades.
If there is a bond bubble, I would focus on the fact that there is no term premium for holding long-term bonds over the average of short rates as dangerous sign. The term premium can jump without much change in the underlying real rate or expected inflation. This will create a risk that will force investors out of bonds. If perception of bonds risks change, we can see a sell-off which may not be directly related to higher inflation or economic growth.
If there is a bond bubble, I would focus on the fact that there is no term premium for holding long-term bonds over the average of short rates as dangerous sign. The term premium can jump without much change in the underlying real rate or expected inflation. This will create a risk that will force investors out of bonds. If perception of bonds risks change, we can see a sell-off which may not be directly related to higher inflation or economic growth.
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