Even as expectations mount for an eventual rate cut by the Federal Reserve, 10-year bond yields since March traded within a range of 4.15% to 4.50%.
What’s keeping yields in that range can be explained by the role of the risk premium in the setting of interest rates. The so-called term premium is now estimated at 0.65% after being negative for much of the past decade and a half.
Interest rates are determined as the sum of expectations for short-term rates plus the term premium for holding a bond until maturity, according to the model developed by the economists Tobias Adrian, Richard K. Crump, and Emanuel Moench.
This term premium is demanded by investors to compensate for the risk that monetary policy might have to follow a different path than expected.
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In this case, the market appears to be pricing in the possibility of additional rate hikes should inflation continue to increase as tariffs are implemented.
As of the last week of July, market trading had 10-year Treasury yields at 4.40%. That would cover expectations of a federal funds rate of 3.70% plus a term premium of 0.75%.
That puts 10-year yields somewhere between the period of generally higher interest rates of the 1990s to early 2000s, and the post-financial crisis era of disinflation and extremely low interest rates.
