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A hidden risk appears to be building up in the markets. No one knows exactly what it means

If you look only at the obvious numbers, you wouldn’t ever see it.

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市场中似乎正在酝酿一种隐患。没有人确切知道这意味着什么。

Charly Triballeau/AFP/Getty Images

If you look only at the obvious numbers, you wouldn’t ever see it.

But an estimate of potential risk that’s hidden to all but the most attentive investors and economists has been building up in the bond market for months. It’s called the term premium, and it just hit a 12-year high.

No one knows precisely why the wonky metric seems to be saying it’s riskier now to invest for the long haul than it was during the inflation crisis, the global trade war or the pandemic. But it’s got one corner of investors sweating.

It could be nothing but noise. It could reflect nervous energy among investors. Or it could signal that the bond market is pricing in even more economic danger than people realize.

Here’s what’s going on. (And don’t worry, we’ll hold your hand through some seriously nerdy stuff.)

If you’re an investor who wants to buy Treasuries over the course of the next 10 years, you have multiple options available to you. For example, you could buy a 10-year bond. Or you could buy a 5-year bond and roll it over halfway through the decade. Or you could buy a 2-year bond and roll your investment over five times. You get the picture.

In a perfect world, the cost of buying a long-term bond should be the same as rolling over short-term bonds in the same time period. A decade is a decade no matter how you slice it. The risk is the same.

But we don’t live in a perfect world; we live in a cloud of uncertainty.

Right now, investors have put a significant premium on buying 10-year Treasuries compared to short-term bonds that roll over multiple times throughout the next decade. The term premium estimates the value of that extra charge. According to two models , it hasn’t been this high since the spring of 2014.

Still confused? Think of it this way.

Let’s say you have a hungry kindergartner. You give her a candy bar and tell her: “I want you to wait 10 minutes before you eat this. I’ll be back to check on you.”

The likelihood that the kid is going to chow down is probably higher if you leave her alone for 10 whole minutes than if you check in on her every two minutes.

But the term premium can be negative, too, as it was throughout the pandemic and as recently as two years ago.

In that case, the kindergartner isn’t hungry – she’s spiteful. She’s more likely to eat the candy if you keep tabs on her every two minutes than trust her to hang on to it for 10 minutes. The near-term risk is higher than over the long haul.

Right now, the market appears to be telling us that the kindergartner is ravenous and investing for the next 10 years could come with some considerable risk.

Now, the even trickier part is understanding why the term premium is suddenly so high.

Certainly, there’s a ton of risk in the marketplace. Investors are uncertain about AI, ballooning debt, the Iran war, geopolitical uncertainty… but the past 12 years were pretty bananas, too: Is it really less safe to invest over the next decade than at any point since 2014?

Market analysts and economists note the term premium is poorly understood and subject to interpretation.

Among the possibilities:

It’s riskier to invest now: The simplest interpretation is that long-term investing really is riskier now than in the past.

AI spending is measured in the trillions of dollars, and the rapidly developing technology is reshaping the economy in ways that are difficult to predict or understand.

The International Monetary Fund on Tuesday said rising government debt across the world is becoming unsustainable. Populist economic policies have found favor on the left and the right, and neither spending reductions nor higher taxes have much support among most major economies.

The Iran war has reignited worldwide inflation without a clear endgame, and President Donald Trump left open the possibility of resuming US attacks on Iran after the midterms. Central banks around the world would probably respond to even higher fuel prices by raising interest rates.

All those factors are sending bond yields to multi-decade highs, raising the cost of borrowing and threatening to slow economic growth. But inflation from AI and fuel shortages may not slow down even if the economy cools off, potentially complicating the government’s ability to intervene with emergency action if necessary.

Li Rui/Xinhua/Getty Images

And one unpredictable dynamic that could throw a wrench in the economy’s gears: shifting geopolitics. France may elect its first far-right president since World War II. The UK’s welfare state is crumbling. The Middle East is a powder keg. China and the United States are engaged in a high-stakes battle for AI supremacy. And US midterms could yield unpredictable results in November.

“It’s important that economists like myself and other capital markets professionals remain humble about our own Achilles heel: its geopolitics,” said Joe Brusuelas, chief economist at RSM US. “We get it mostly wrong, our models and metrics rarely capture those dynamics and are often behind the curve when things get kinetic.”

Investors think it’s riskier to invest now: But the term premium doesn’t necessarily measure actual risk. It could measure the perception of risk for investors.

“Don’t infer because there’s a higher risk premium, there’s higher risk,” said Thierry Wizman, economist at Macquarie Group. “It could just be that people are more averse to risk.”

Like a gambler riding a hot streak, investors staring at record-high stock prices and a fast-growing economy may become nervous that their luck is about to run out.

Economic conditions haven’t really changed all that much recently: Unsustainable debt loads have been a problem for decades. AI growth has been on a massive upward trajectory for years. Inflation has been above the Federal Reserve’s 2% target for five years.

But something may be rattling investors, and they’re looking for insurance to park their money over the long haul.

“Prices look calm, but people are quietly buying insurance everywhere,” said Nigel Green, CEO of DeVere Group. “Typically, when everyone’s nervous but prices haven’t moved, things don’t adjust gently if the bad news comes; they lurch.”

The model is wrong: It’s also possible that the model isn’t saying what we think it is.

The recent rise in the term premium may have nothing to do with Iran, AI or debt at all. It could be explained by technical factors. For example, large funds may have been rebalancing their portfolios at the end of the third quarter.

“Because the term premium represents the component of a bond yield that cannot be explained by the expected path of short-term interest rates, it is difficult to identify precisely what drives it,” noted Neil Shearing, economist at Capital Economics.

So the best we can do is guess – and proceed with caution.

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