There Is a Long-Term Danger Lurking in Financial Markets

livemint.com:

Contrary to popular belief, financial markets have a long-term bias. This isn’t always a good thing. There is much talk among investors of a “new regime." Those words headline BlackRock’s recent midyear outlook, for example, which emphasized how the trends of the past decade—low interest rates and volatility, with bonds cushioning stock selloffs—have reversed in the past two years.

Weirdly, however, one indicator from the era of near-zero rates has remained unchanged: Markets don’t demand much extra return in exchange forlocking away their money for longer periods. This can be inferred from data published daily by the Federal Reserve, which estimates the “term premium" needed for investors to buy 10-year government bonds, rather than stash their money in, say, a money-market fund. In theory, the yield on risk-free government paper should be equal to the interest rate investors expect on average until the debt is paid back.

In practice, this only holds true for short-term bonds. Unless an investor or a market maker is 100% sure that a 10-year bond will be held to maturity, there is a risk that it will need to be sold at an unfavorable time. Without a discount for 10-year paper, giving a yield premium, it would make more sense for investors to roll over 10 one-year bonds.

This term premium has added an average 1.5 percentage points to 10-year yields since 1961. After 2016, though, ultralow rates, quantitative easing and low inflation turned it negative. Even now that inflation has shot up and rates have risen, this anomaly persists: On Friday, the term premium was a negative 0.75 percentage point.