US financial conditions through the lens of Treasury term premia

After the Federal Reserve's 50 basis point rate cut this month, what comes next?

This chart uses the Adrian, Crump, and Moench (ACM) model to analyze Treasury yields. A simplified explanation of the utility of this model: It aims to visualize the "term premium" -- i.e., what investors demand to "lock up" their money in 10-year securities rather than rolling over short-term bills. (CEIC offers our users this ACM Term Premia dataset.)

Investors who expect interest rates to rise will want more premium. Indeed, we can see that the premium went into positive territory for much of the inflation and rate-hiking cycle of 2022. For much of the past two years, however, the premium was in negative territory -- implying that lower rates were seen as likely, an expectation that took a long time to come true.

We've charted this against a more widely known forward-looking gauge: the Fed's probability of raising or lowering rates -- calculated as a weighted net balance of probabilities of Fed Fund rate changes by CME Group.

After the Fed's bold rate cut, term premia are at their lowest in 20 years -- indicating more rate cuts are seen as likely.

Our second chart takes a slightly longer-term view, contrasting 1-year Treasury term premia with broader financial conditions (as measured by the National Financial Conditions Index). And our final visualization suggests that 10-year Treasury term premia tend to track changes in broader economic activity, as represented by the Dallas Fed's Weekly Economic Index.

If you are a CEIC user, access the story here.