The United States: New Policy Variables Emerging – Term Premium
2023-10-16
■ Among senior officials of the Federal Reserve (FRB), there has been an increase in proposals to delay further interest rate hikes due to the sharp rise in long-term interest rates
■ The expansion of term premiums has become an obstacle to sustained high-interest rate policies, and stability has become a new policy focus
Influenced by the rise in the yield of US treasury bonds, since the 5th of this month, many senior officials, such as the President of the Federal Reserve Bank of San Francisco, the President of the Federal Reserve Bank of Dallas, and the Vice Chairman of the Federal Reserve Board (FRB), have advocated the necessity of slowing down interest rate increases. Among them, the President of the Dallas Federal Reserve Bank pointed out that the sharp rise in long-term interest rates in the United States in recent months is not a reflection of economic strength, but an expansion of term premiums, and the rise in long-term interest rates will become a part of suppressing the economy. Although decision-making is still based on data, the trend of market interest rates is shaping FRB's policies.
The term premium mentioned by the President of the Dallas Federal Reserve Bank refers to the interest rate (risk premium) that gradually increases based on the remaining term in bond investments, in order to ensure the interest rate on the maturity date and accept interest rate fluctuations and liquidity uncertainty during this period. Term premium is an estimated value that cannot be directly observed as a specific increase in market interest rates. However, the estimated 10-year term premium released by the Federal Reserve Bank of New York turned positive in late September, suggesting that the expansion of term premium is one of the reasons for the recent rise in long-term interest rates in the United States. In early August of this year, during the early stages of the rise in long-term interest rates in the United States, the author pointed out that "the expansion of term premiums is expected to have an impact on market interest rates without involving economic fundamentals and policy interest rate adjustments." * 1 This trend has indeed been observed in the market.
In the September US Consumer Price Index (CPI) released yesterday, the core CPI (with a year-on-year increase of 4.1%) excluding food and energy narrowed. As of October 31, and November 1 of the Federal Reserve Open Market Committee (FOMC) meetings, the market had already expected to postpone interest rate hikes, which was fully considered in the financial market. It is expected that the Federal Reserve will continue to maintain a high level of policy interest rates after raising interest rates, even if inflation slows down, and continue to tighten monetary policy through an increase in real interest rates. The stability of market interest rates is a prerequisite, and if the term premiums continue to expand, the financial environment will quickly tighten. It is expected that the stabilization of term premium will become a new policy focus at future FOMC meetings, which may involve the speed of the Federal Reserve's balance sheet reduction.
*1 For details, please refer to PRESTIA Insight 2023.08.04 "US: Large scale US treasury bond issuance plan since the CARES Act".
■ The expansion of term premiums has become an obstacle to sustained high-interest rate policies, and stability has become a new policy focus
Influenced by the rise in the yield of US treasury bonds, since the 5th of this month, many senior officials, such as the President of the Federal Reserve Bank of San Francisco, the President of the Federal Reserve Bank of Dallas, and the Vice Chairman of the Federal Reserve Board (FRB), have advocated the necessity of slowing down interest rate increases. Among them, the President of the Dallas Federal Reserve Bank pointed out that the sharp rise in long-term interest rates in the United States in recent months is not a reflection of economic strength, but an expansion of term premiums, and the rise in long-term interest rates will become a part of suppressing the economy. Although decision-making is still based on data, the trend of market interest rates is shaping FRB's policies.
The term premium mentioned by the President of the Dallas Federal Reserve Bank refers to the interest rate (risk premium) that gradually increases based on the remaining term in bond investments, in order to ensure the interest rate on the maturity date and accept interest rate fluctuations and liquidity uncertainty during this period. Term premium is an estimated value that cannot be directly observed as a specific increase in market interest rates. However, the estimated 10-year term premium released by the Federal Reserve Bank of New York turned positive in late September, suggesting that the expansion of term premium is one of the reasons for the recent rise in long-term interest rates in the United States. In early August of this year, during the early stages of the rise in long-term interest rates in the United States, the author pointed out that "the expansion of term premiums is expected to have an impact on market interest rates without involving economic fundamentals and policy interest rate adjustments." * 1 This trend has indeed been observed in the market.
In the September US Consumer Price Index (CPI) released yesterday, the core CPI (with a year-on-year increase of 4.1%) excluding food and energy narrowed. As of October 31, and November 1 of the Federal Reserve Open Market Committee (FOMC) meetings, the market had already expected to postpone interest rate hikes, which was fully considered in the financial market. It is expected that the Federal Reserve will continue to maintain a high level of policy interest rates after raising interest rates, even if inflation slows down, and continue to tighten monetary policy through an increase in real interest rates. The stability of market interest rates is a prerequisite, and if the term premiums continue to expand, the financial environment will quickly tighten. It is expected that the stabilization of term premium will become a new policy focus at future FOMC meetings, which may involve the speed of the Federal Reserve's balance sheet reduction.
*1 For details, please refer to PRESTIA Insight 2023.08.04 "US: Large scale US treasury bond issuance plan since the CARES Act".