Wall Street’s Latest Obsession Is an Unknowable Number

livemint.com:

Investors and Federal Reserve officials scrambling to make sense of surging U.S. Treasury yields have a new obsession: a number that exists only in theory. Known as the term premium, the number is typically defined as the component of Treasury yields that reflects everything other than investors’ baseline expectations for short-term interest rates set by the Federal Reserve.

That could include anything from an increase in the supply of bonds to harder-to-pin down variables such as uncertainty about the long-term inflation outlook. In recent weeks, debate around the term premium has intensified because some financial models have suggested that it has been rising sharply—driving much of a recent surge in longer-term Treasury yields that has carried the yield on the 10-year note above 4.8% for the first time since 2007. Treasury yields help dictate interest rates on everything from mortgages to corporate debt, making their rise over the past two years a steady source of anxiety for investors.

So far, those worries have proved mostly unfounded, as the economy has shown little signs of buckling under the higher borrowing costs. Yet the recent evidence of rising term premiums has provided a new source for concern. For some, they suggest that yields are no longer rising because of a strong economy and expectations for higher rates.

Instead, the underlying cause could be something harder for the Fed to control and therefore more dangerous. Still, even economists who created term premium models stress that their outputs are imperfect estimates, making it difficult to gauge whether or not they are a warning. Here’s a look at the current debate.