Term Premium

Suppose you want to invest for ten years. You could buy a single 10-year bond, or you could buy a 3-month bill and keep reinvesting it forty times over. In theory, if both strategies covered the same period, they might offer the same total return — but in practice, the 10-year bond carries extra risks: inflation could rise, interest rates could change, and your money is locked up. The term premium is the additional yield the market attaches to the 10-year bond to compensate for those uncertainties. It is part of what gives the yield curve its normal upward slope.

The term premium is not directly observable — it has to be estimated by economists using models that strip out expectations of future short-term rates. When model estimates show the term premium rising, it often reflects investor concern about inflation, government borrowing levels, or broader volatility in bond markets. When it falls or turns negative, it can mean strong demand for long-term bonds as safe-haven-style assets.

A common confusion: a rising term premium and rising rate expectations can both push long yields higher, but they have different economic meanings. A yield increase driven by a higher term premium reflects compensation for risk and uncertainty; one driven by stronger growth expectations reflects optimism about the economy. Separating the two matters to economists trying to read what bond markets are actually signaling. See the guide on financial markets for broader context.