This post was taken from our weekly report, dated October 15, 2019.

In the last month yields have since then done a round trip, falling and then rising again, but crucially term premium (TP) has not fallen. It was TP’s relentless fall through 2019 that meant the (2s10s) yield curve moved sideways or flattened (and eventually inverted) and did not steepen, even while short-term rates were falling (top chart).

TP correlates well with fixed-income volatility and inflation volatility – in essence it is the extra premium charged by longer-term lenders for uncertainty. Since the crisis, TP has relentlessly fallen due to large, inelastic buyers of government debt in the form of central banks. However, the ECB’s appeal for more fiscal activism in stimulating the economy; the BoJ’s withdrawal from buying longer-dated JGBs as it is finding it increasingly difficult to control the yield curve; and the repo-funding issues in the US are all indicative of conventional monetary policy nearing its limits, and central banks struggling to control the heightened sensitivity of their bloated balance sheets to asset prices and – through excessive leverage – the real economy. Term premium is rising to reflect this. Case in point: the Fed announced last week it will buy $60bn of bills per month (crucially this is not QE) to try to prevent further funding problems. This should lead to a more volatile Fed balance sheet, which generally means higher term premium (last chart).

(Click on image to enlarge)

Source: Bloomberg, Macrobond, Variant Perception