The bond market is experiencing a notable shift as the term premium, often described as the "dark matter" of bond yields, suggests further increases in yields. Federal Reserve President Neel Kashkari has highlighted the term premium as a key factor in understanding bond yield movements, despite its elusive nature. The term premium, which reflects the additional return investors demand for holding longer-term bonds amid potential volatility and inflation risks, is rising. This increase is driven by heightened bond volatility and a positive stock-bond correlation, which diminishes bonds' role as a hedge and pushes yields higher.
The current market environment, characterized by a steepening yield curve, is encouraging traders to short longer-term bonds, sustaining elevated yields. With a low near-term recession risk and potential economic re-acceleration, the conditions are ripe for continued high yields. The term premium's rise aligns with a narrowing output gap, suggesting that while yields remain high, they could eventually constrain economic growth. As of January 14, the 10-year Treasury yield stands at 4.80, unchanged from its last close, reflecting these underlying dynamics.