Term Premium and Tightening Market Conditions
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The Fed may slow or stop increasing rates as term premium in bonds is doing a lot of their work for them. Higher rates are a large blunt instrument that has many impacts on the market.
Why does Term Premium and Tightening Market Conditions matter?
Term premium means people want more / higher rates to invest in long-term treasuries, and this leads to:
Higher Borrowing Costs: When the term premium rises, the yield on long-term bonds like 10-year government bonds also increases. This has a cascading effect on interest rates across various financial instruments, making borrowing more expensive for consumers and businesses.
Reduced Investment: Higher borrowing costs can deter businesses from taking out loans for capital expenditures, thereby slowing down investment and economic growth.
Asset Repricing: A higher term premium can lead to a decrease in the price of existing bonds, affecting portfolios and potentially leading to capital losses for investors so they feel poorer.
Credit Availability: Banks may become more risk-averse in a high term premium environment. This can lead to tighter lending standards, making it harder for consumers and businesses to access credit.
Consumer Spending: Higher interest rates generally discourage consumer spending, especially on big-ticket items that often require financing, like homes and cars.
When term premium is positive, people want higher incentives to lend their money to the government, which means higher costs for the government to support that debt.
The upside, consumers earn more on their cash.