Long-term yields aren't just expectations about future short rates. They include a 'term premium' — extra compensation for holding duration risk.

What is Term Premium?

When you buy a 10-year bond, you're locking up money for 10 years. A lot can go wrong: inflation could surge, rates could spike, you might need the money. The term premium is compensation for these risks.

Breaking Down the 10Y Yield:

10Y Yield = Expected Short Rates + Term Premium

• Expected Short Rates: What markets think Fed policy will average over 10 years
• Term Premium: Extra yield for duration risk

Historically, term premium was positive (1-2%). Investors demanded extra yield for locking up money. But after 2008, it often went negative — investors were so hungry for safe assets (QE, pension demand, foreign buyers) that they accepted LESS yield to own long bonds.

When Term Premium Matters:

Rising Term Premium (2023):

• Supply concerns (budget deficits → more bonds to issue)
• Inflation uncertainty
• Foreign buyers stepping back
• 10Y rises even without changed rate expectations
• Stocks struggle as discount rates rise

Falling Term Premium:

• Flight to safety (crisis demand)
• Fed buying (QE)
• Foreign central bank buying
• 10Y falls even if rate expectations stable

October 2023 Example:

The 10Y spiked to 5% — highest since 2007. Fed Funds hadn't changed. Rate expectations were stable. The move was almost entirely term premium — investors demanding more compensation for holding duration amid deficit concerns. This showed term premium moves can dominate rate expectations.