PIMCO, a leading bond investment firm in the US, anticipates an increase in term premiums
New York, Bollywoodfever, February 29: PIMCO, a prominent U.S. bond management firm, has indicated that term premiums for U.S. Treasury bonds could see an upward trajectory due to persistent inflation and increasing fiscal deficits.
Term premiums, the additional yield investors require to hold longer-term bonds, have been relatively low for the past decade, a trend influenced by the low-interest-rate environment post the 2007-2009 financial crisis and the COVID-19 pandemic.
This marked a continuation of the gradual decrease in premiums since the 1980s. We are at a pivotal point where the term premium could begin to climb back up, reversing a 40-year trend of decline,” stated Marc Seidner, PIMCO’s Chief Investment Officer of Nontraditional Strategies, and Pramol Dhawan, a portfolio manager at the firm, in a recent publication.
They pointed to January’s unexpected high inflation figures and forecasts of increased fiscal deficits, along with the anticipated rise in debt issuance to cover these deficits, as key factors that could lead to a sustained increase in term premiums.
“Borrowing costs have escalated alongside persistent deficits, leading to an inevitable increase in interest expenses,” stated PIMCO representatives. Currently, the term premium for the benchmark 10-year Treasury yields stands at negative 0.3%, as per the New York Federal Reserve’s measurement.
This figure briefly shifted into positive territory last year due to concerns over growing fiscal deficits and a surge in government bond issuance, which pushed up long-term Treasury yields (which have an inverse relationship with bond prices). However, it slipped back into negative amid speculation of forthcoming interest rate reductions by the Federal Reserve.
Seidner and Dhawan noted that a resurgence of term premiums to the approximately 2% levels observed in the late 1990s and early 2000s would impact not just bond prices but also the valuations of equities, real estate, and any assets priced through discounted future cash flows.
They further explained that the Treasury yield curve, which is currently experiencing inversions in some parts (where short-term bonds yield more than their longer-term counterparts), might normalize with the increase in term premiums, especially if the Federal Reserve proceeds with expected rate cuts.
PIMCO has strategically positioned its portfolio with a preference for bonds maturing in five to 10 years on a global scale, maintaining a lesser exposure to bonds nearing 30 years due to a “curve-steepening bias.
The note elaborated on the potential for a distinct shift in the yield curve following the Federal Reserve’s initial rate cut. This shift would likely see short-term yields decrease, intermediate rates remain relatively stable, and long-term yields ascend as term premiums make a significant return.
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