US: Term Premium and the Fed’s “Third Duty”

■ Term premiums are at their highest level since 2014, reflecting market concerns about economic and policy uncertainties.  

■ Sharp fluctuations in term premiums may become an obstacle for the Federal Reserve to maintain its third mandate of "moderately long-term interest rates." 
 
The upward trend in global long-term interest rates has intensified, with the yield on the 10-year US Treasury note rising above 4.68% on May 19, the highest level since January 2025. As the surge in oil prices has temporarily subsided, the upward momentum of yields has begun to be restrained, but it remains at a relatively high level (the latter half of the 4.47% range on June 4). The main reason is market concerns about a possible blockade of the Strait of Hormuz and the resulting expectation of sustained high oil prices. As a representative indicator of long-term inflation expectations in the financial market, the break-even inflation rate (BEI) of the 10-year US Treasury Inflation-Protected Securities (TIPS) rose above 2.61% in May, reaching its highest level in about a year. Furthermore, the 10-year term premium (approximately 0.67% on June 3rd), measured by the difference between the yield on traded Treasury bonds and the weighted average of expected policy rates for the same period, has remained at its highest level since 2014, since the implementation of the "reciprocal tariffs" last April. The term premium is generally seen as compensation demanded by investors for various uncertainties in predicting future economic conditions (economic growth rate, inflation rate) and fiscal and monetary policies (Treasury bond issuance size, policy rates), i.e., an additional interest rate premium, thus reflecting the increased unpredictability of the current economic and policy outlook. 
 
While the Federal Reserve's (FRB) monetary policy objectives are generally summarized as "two mandates"—"maximizing employment" and "maintaining price stability"—the Federal Reserve Act actually stipulates a third mandate—maintaining "moderate long-term interest rates." Therefore, when market interest rate volatility, such as the yield on 10-year Treasury bonds, increases, the market's demand for monetary policy responses also strengthens, and the term premium can be considered one of the important indicators for measuring this situation. In addition to adjusting policy interest rates, central banks also indirectly control the yield curve by influencing market expectations about the future path of policy interest rates through forward guidance and policy communication. Therefore, a sharp widening or narrowing of the term premium indicates a weakening influence of the central bank on market interest rates. 

 
The trend of a sustained widening of the 10-year term premium from 2023 to mid-2025 has now been curbed. Although the current yield on 10-year US Treasury bonds remains relatively high relative to the policy interest rate path, it has not yet reached a level that raises concerns about the sustainability of "moderately long-term interest rates." However, with rising long-term inflation expectations, the future policy interest rate path may shift upwards overall, putting further upward pressure on the yield on 10-year US Treasury bonds; simultaneously, uncertainty about the outlook for prices and monetary policy will also drive the term premium to widen. Under normal circumstances, stabilizing the real economy by fulfilling the "two responsibilities" is usually sufficient to achieve the "third responsibility"; however, if the term premium continues to widen, leading to a weakening of the transmission effect of monetary policy, it may increase the necessity of implementing unconventional monetary policies and strengthening coordination with fiscal policy.