More than a few forecasters see that trend as a worrying sign the U.S. economy and corporate earnings aren’t strong enough to justify S&P 500 index’s 17 percent rebound from its December low. Richard Kelly, Toronto-Dominion Bank’s head of global strategy, said it’s “one of the signs that we still aren’t out of the woods.” Evercore ISI’s Dennis Debusschere suggested the deeply negative term premium reflects pessimism about nominal growth.

Indeed, the S&P 500 just capped its worst week of the year after China dialed back its goal for economic expansion, the European Central Bank downgraded its euro-area outlook and a report showed American hiring slumped.

Long View
Dudley, former head of New York Fed, is inclined to take the long view. The long, steady decline of the term premium, which has brought down U.S. borrowing costs, ultimately has more to do with the Fed breaking the back of inflation. Technological advances, not to mention the Amazon effect, have also made everything cheaper for Americans over the years. Among consumers, the inflation outlook over the next five to 10 years has fallen to 2.3 percent, according to a University of Michigan survey, matching a record low.

As a result, the most pessimistic take isn’t necessarily the right one, he said.

“As long as this inflation regime holds, and we remain in a world where people aren’t worried about budget deficits, then bond risk premiums will probably stay low,” said Dudley, who is now a professor at Princeton University. (He’s also a contributor to Bloomberg Opinion.)

Dudley added that it probably means a recession is unlikely in the near future, even if long-term bond yields fall below short-term rates, a phenomenon that’s historically preceded contractions.

Model Hiccups
Goldman’s Praveen Korapaty and Binky Chadha of Deutsche Bank say the term premium might not even be as low as some models suggest. While many incorporate an average short-term rate that’s over 3 percent, Fed officials say the current 2.25 percent to 2.5 percent target rate is already close to the lower end of their range of estimates for neutral -- the level that neither slows nor spurs growth. Goldman’s model puts the term premium at minus 0.3 percentage point, roughly half as low as the New York Fed’s popular ACM model.

“These models have the view that the very long-run neutral rate is constant,” said Jonathan Wright, an economics professor at Johns Hopkins University and co- creator of ACM’s predecessor, the Fed’s Kim-Wright model. “Since the crisis, there has been a lot of evidence that the neutral rate has fallen.”

Then, there’s the Fed’s $2.18 trillion of Treasury holdings. A legacy of quantitative easing, the purchases of U.S. government debt are estimated to have reduced the term premium by a full percentage point. While the Fed is now steadily paring its holdings, the opposite hasn’t happened. That’s raised some eyebrows. And since January, Fed officials have started to put the market on notice that the unwind will likely end later this year.

Structural Distortion
Tobias Adrian, the International Monetary Fund’s financial stability chief and a former New York Fed researcher, says the reason may be structural in nature.