On Thursday, U.S. bond asset manager PIMCO warned that sticky inflation and mounting fiscal deficits might raise Treasury term premiums, which investors demand for holding long-term bonds.
For a decade, low interest rates after the 2007-2009 global financial crisis and the COVID-19 epidemic have depressed term premiums, which can damage equities. Premiums have been falling since the 1980s.
"We are at a moment when the term premium could start to reverse the 40-year downtrend," PIMCO portfolio manager Pramol Dhawan and unconventional strategies chief investment officer Marc Seidner wrote.
They predicted term premiums could rise again due to January's stronger-than-expected inflation and recent estimates on increased fiscal deficits and debt issuance to support them.
Ongoing deficits and borrowing costs have increased. We can almost guarantee growing interest expenses "said. The New York Fed measures the 10-year Treasury yield term premium at minus 0.3%. It became positive last year as concerns about expanding fiscal deficits and government bond issuance lifted long-term Treasury rates, which move inversely to prices, but they fell again on Fed interest rate decrease forecasts.
The late 1990s and early 2000s' 2% levels "would not only affect bond prices but also prices of equities, real estate, and any other asset that is valued based on discounted future cash flows," stated Seidner and Dhawan.
They said that rising term premiums and a much-anticipated Fed rate cut might correct the Treasury yield curve, which is inverted because certain short-term bonds yield more than longer-term ones. PIMCO stated it has a "curve-steepening bias" in its portfolios, favoring five- to 10-year maturities globally and underweighting 30-year bonds.
"There is a very real possibility that the curve could kink following the first Fed rate cut, with shorter-term yields declining, intermediate rates not moving much, and longer-term yields rising as the term premium stages a comeback," it added.
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