📝Model Shows Term Premium Has Room to Increase In Euro Area: Nordea

We have tried to model the reduction in the term premium in longer interest rates due to the ECB’s bond purchases with the help of a simple regression model, where we use market expectations for short rates, inflation and growth to model the level of the 10-year swap rate. We have fixed the coefficients from a time period before the start of the ECB’s bond purchases, and examined how the actual level of rates has diverged from the model-implied yield after the purchases.

This examination suggests that at its peak, the QE-induced term premium was more than 1.5 percentage points at its peak last year, but has since fallen to 60-70bp. In other words, while the QE premium has already been reduced, it still exists, leaving the term premia clear room to increase going forward. Again, we do not expect the term premium to be the major driver of long yields, as cyclical considerations will most likely trump the impact of changes in the term premium, but other things equal, higher term premium should mean higher yields. - Nordea