Term premia make a comeback
Back
Article Type
Insights
Topic
Opinion
Published
May 30, 2025
Read time
6 mins
Author
Luca Ferramosca, CFA
Share

The resurgence of term premia across developed market rates has recently drawn significant investor attention. The long end of the yield curve in key economies—including Japan, the United States and the Euro Area—has experienced an aggressive sell-off. This move reinforces a broader trend that began when market narratives shifted from concerns over global growth derating to a more acute focus on deteriorating fiscal dynamics. This pivot was particularly evident following the temporary de-escalation of US-China trade tensions, which removed a key tail risk and refocused attention on structural deficits and rising debt burdens. The resulting price action underscores a repricing of long-term risk, as investors demand greater compensation for duration exposure.

 

Last week’s price action reveals mounting market concerns over sovereign debt sustainability and the potential re-emergence of “bond vigilantes” interventions. The week kicked off with Moody’s downgrade of US sovereign credit, which, despite its headline significance, elicited a muted reaction from market participants, suggesting that the move was largely priced in. This was followed by a weak 20-year Japanese Government Bond (JGB) auction, highlighting persistent fragility in supply-demand conditions within the super-long sector. On Wednesday, the 20-year US Treasury auction was similarly underwhelming, with tepid bidding metrics despite indications of ongoing foreign participation. In Europe, long-end EUR swap rates came under renewed steepening pressure after the Dutch parliament rejected a key amendment to the pension reform bill.

 

10s30s Curves in bps


Source: Aegon Asset Management, Bloomberg

 

Japan 


Japan’s elevated sovereign debt burden—standing at approximately 236% of GDP on a gross basis—continues to weigh on investor sentiment. While from an historical perspective the current level is not as alarming as one might think, persistent above-target inflation and a decisive shift away from ultra-accommodative monetary policy have reignited concerns over the sustainability of public finances. 


From a local institutional investor's perspective, some large insurance companies, such as Nippon Life, have indicated consistent purchases of super-long JGBs, citing attractive yields, while Dai-ichi Life appears more cautious. Structural demand from life insurers has waned as many have reached their hedging targets with their duration gap the most negative on record, contributing to persistent supply-demand imbalances. This has been evident in recent auction tails at the long and ultra-long end of the curve. Compounding these pressures are Japan’s fluid political landscape, the Bank of Japan’s ongoing policy normalization, and rising debt servicing costs—all of which have steepened the 10s30s curve and driven long-end swap spreads tighter.


In response to market concerns, recent commentary from the Ministry of Finance suggests a more proactive stance. Officials have floated the possibility of reducing super-long bond supply while increasing medium-term issuance to better align with investor demand. A questionnaire has reportedly been circulated among primary dealers to gauge appropriate issuance sizes at the long end, signaling potential recalibration in the upcoming fiscal quarters.

 

US


Moody’s downgrade of US sovereign debt, coupled with the House’s passage of the new tax bill, has reignited concerns around rising term premia. The “sell America” trade has gained momentum, particularly since the announcement of sweeping reciprocal tariffs on Liberation Day. The US dollar index (DXY) has declined nearly 10% from its January 2025 highs, reflecting a broader shift in sentiment. Notably, EUR/USD fair value estimates have decoupled from traditional rate differentials, coinciding with increased market pricing of US stagflation risk and speculation over potential Treasury liquidations by foreign official accounts.
While fears of large-scale foreign selling, particularly by Chinese investors, have yet to be substantiated by custody data, stress has emerged in segments of the Emerging Markets FX complex. Currencies of countries with large external surpluses, such as the Taiwanese dollar (TWD), have seen sharp appreciations, highlighting localized de-dollarization pressures. This theme has been reinforced by broader discussions around the unwinding of unhedged USD exposures, which had delivered attractive returns over the past decade. Although expectations for rising hedge ratios are now firmly embedded, actual positioning in FX forwards, such as the EUR/USD 3-month forward, has yet to reflect a material shift in hedging behavior.


The sustained weakness in USD crosses has introduced a new paradigm for term premium pricing along the US Treasury curve. Historically, the DXY and term premia exhibited a positive correlation, but this relationship has recently turned negative. This shift underscores the fragility of investor sentiment regarding US fiscal sustainability, particularly considering the “big, beautiful” tax bill, which is projected to add approximately $2.7 trillion to the 10-year deficit. The front-loaded nature of the bill has exceeded Congressional Budget Office (CBO) estimates, with an additional $200–300 billion in net deficit. While tariff-related revenues and potential productivity gains may eventually offset some of the fiscal drag, the near-term trajectory remains unsustainable.


A more meaningful reprieve in term premia would likely require a combination of factors: renewed confidence in Fed rate cuts, driven by weaker incoming hard data; a decoupling of global long-end rate correlations; and stronger demand signals, particularly from upcoming long-end Treasury auctions, which are not expected until mid-June.

 

DXY and ACM Term Premium

Source: Aegon Asset Management, Bloomberg1 

 

Eurozone


The broader European fiscal landscape echoes similar concerns. Intermediate and long-end tenors continue to embed elevated term premia, a legacy of the German fiscal “bazooka” and the EU’s ReArm Europe initiative. While ongoing EU–US trade negotiations have helped anchor Bund yields, especially as equity markets have priced in a fair degree of optimism, risks remain skewed. Renewed risk-off sentiment or political fragmentation that hampers the implementation of fiscal stimulus could prompt a repricing lower across the term structure.
The “elephant in the room” for the EUR rates curve remains the Dutch pension reform. Following last week’s failed parliamentary vote on a proposed amendment to the reform, long-end steepeners have regained momentum, as investors anticipate that Dutch pension funds may be forced to shorten the duration of their hedging portfolios. While the sector as a whole remains comfortably above the 105% coverage ratio threshold, significant disparities exist across individual funds.


Currently, Dutch pension funds hedge approximately 65% of their liabilities on average. However, under the new regulatory framework, hedging ratios will need to be recalibrated based on asset values rather than liabilities. This transition implies a structural need for de-risking, which is expected to trigger a reduction in ultra-long duration hedges and increased receiving activity in the 20–30 year segment of the swap curve.


Optimism remains under pressure


The latest wave of fiscal concerns is unfolding just as trade tensions appear to be easing, with a more constructive tone emerging in negotiations between the US and its key trading partners. Markets have become increasingly desensitized to the combative rhetoric from President Trump, with headline risk notably diminished. This was evident in the relatively muted reaction on Friday, May 23rd, when Trump announced a 50% tariff on EU goods. While the effective tariff rate has come down meaningfully from the post-Liberation Day highs, the broader step-up in macro uncertainty is still weighing on consumer and business sentiment globally.


This backdrop continues to act as a drag on more optimistic growth forecasts. While front-end yields in developed market curves may stay anchored around current levels, ongoing deficit concerns are likely to keep pressure on the back end of the yield curves.

 

1 Adrian Crump & Moench 10 Year Treasury Term Premium.
https://www.newyorkfed.org/research/data_indicators/term-premia-tabs#/overview

 

 

Disclosures

Author

Luca Ferramosca
Portfolio Manager
Luca Ferramosca, CFA, is a portfolio manager with a focus on sovereigns. Prior to his current role, he worked as an institutional sales analyst at Aegon AM. 
View profile
Related Articles
View all Aegon insights