These could include upward pressures on global bond yields - as the compression of
term premiums that followed QE is unwound - and a ratchet up in financial market volatility," Coulton noted.
On the downside, rich asset valuations and very compressed
term premiums raise the possibility of a financial market correction, which could dampen growth and confidence."
Although a weaker dollar can be positive for corporate earnings and lower rates can be favourable for corporate borrowing, equity risk premiums remain wide because of the uncertainty expressed by low bond yields and negative
term premiums.
Jonathan Wright suggested that another approach to avoiding the problem of the zero lower bound is to lower
term premiums through asset purchases, which may be more politically feasible than raising the 2 percent inflation target.
Despite these views, the empirical relationship between the natural real rate and
term premiums is not well understood.
People with little prospect of increasing their income sufficiently to pay ever-increasing
term premiums face a difficult trade-off.
Risk-neutral yields increase, on average, in response to a positive surprise in the Fed funds rate, while
term premiums fall, on average.
However, this relationship ignores
term premiums and the policies directly aimed at lowering long-term yields in the unconventional policy period.
Crucially, Cluttons believes that through such public transportation infrastructure investments, the government is adding long
term premiums to residential values and commercial rents.
The second strand of the literature uses lower-frequency (monthly) data to test the implication of the portfolio balance effect--namely, that there is a positive relationship between bond
term premiums (and, consequently, bond yields) and the maturity structure of the publics holding of Treasury debt and long-term Treasury yields (e.g., Gagnon et al., 2011; Hamilton and Wu, 2012; Krishnamurthy and Vissing-Jorgensen, 2012; Greenwood and Vayanos, forthcoming).
