Macroeconomic shocks drive US term premium fluctuations
A Banca d'Italia working paper analyzes the macroeconomic drivers of the US ten-year term premium. It finds that domestic uncertainty, inflation compensation, and domestic demand shocks explain most of its daily variation.
Uncertainty's central role in US yields
A new Banca d'Italia working paper employs a daily Structural Vector Autoregressive model with sign and narrative restrictions to analyze the macroeconomic drivers of the US ten-year term premium.
This novel framework reveals that domestic uncertainty, inflation compensation, and domestic demand shocks account for the majority of daily fluctuations.
Notably, domestic uncertainty emerges as a central factor, uniquely explaining the strong negative co-movement between the expected short-term rate and the term premium – a previously unobserved stylized fact.
The study highlights the term premium's critical role in long-term US Treasury yields, accounting for most of their volatility, influencing balance sheet policies, and driving international co-movement of sovereign bond yields.
Five forces shaping bond yields
The study identifies five orthogonal macroeconomic disturbances influencing the term premium: monetary policy, inflation compensation, domestic uncertainty, domestic demand, and global risk appetite shocks.
Monetary policy impacts the term premium via asset purchases and guidance on future short-term rates.
Inflation risk is a critical determinant due to long-term bonds' vulnerability to unexpected inflation, with central bank credibility affecting the inflation risk premium.
Domestic uncertainty increases the perceived risk of holding long-duration assets.
Domestic demand shocks capture changes in real economic activity expectations, while global risk appetite reflects shifts in investor sentiment and portfolio preferences.
Refining the yield narrative
This research offers a crucial, real-time lens into the complex dynamics of the US term premium, moving beyond traditional models.
Identifying domestic uncertainty as a key, previously overlooked driver significantly refines our understanding of long-term yield movements.
The findings directly challenge established narratives, offering a more nuanced perspective for central banks and investors.