The term premium is the extra yield investors demand for holding a long-term bond instead of rolling short-term bills over the same horizon. Decompose a 10-year yield and you get two parts: the average expected short rate over the next decade, plus the term premium: compensation for inflation uncertainty, supply risk, and the chance the rate path is wrong.
It matters because it explains long-end moves that Fed expectations cannot. When 10-year yields surge while cut pricing is unchanged, classically after heavy refunding announcements or sticky-inflation scares, that is term premium repricing. It is also unobservable, so the market leans on model estimates like the New York Fed’s ACM series, which spent much of the 2010s negative before rebuilding toward positive territory in the mid-2020s.
Worked example: The 10-year yields 4.35%. Fed funds futures imply an average policy rate of 3.60% over ten years. The implied term premium is roughly 75bp. Treasury then announces larger-than-expected coupon sizes; the 10-year rises to 4.50% with no change in the expected Fed path: a 15bp term premium shock, and 2s10s bear-steepens accordingly.
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