- Tumbling bond prices have rocked Wall Street in recent weeks.
- The meltdown might not be over yet, according to Ned Davis Research.
The bond-market meltdown of the past few weeks might not be over just yet – and there's still a scenario where 10-year Treasury yields top 7%, according to Ned Davis Research.
The benchmark borrowing rate blew past 5% for the first time in 16 years last month, with investors fretting about the Federal Reserve tightening campaign and the US government's debt mountain.
Ned Davis Research's base case is that yields will hold around that level. However, strategist Joseph Kalish said the argument they could shoot above 7% will be "very defensible" if the US economy can dodge a recession and the Fed keeps raising interest rates.
"I cannot rule out a move to 3% or less in a recession or disinflationary scenario, where nominal growth would sink significantly below the rate of interest," he wrote in a research note Tuesday.
"The greater long-term risk, however, is if yields went the other way – toward 7%. Few are thinking about that possibility, but it is very defensible from an historical perspective," Kalish added.
Bond yields, which move in the opposite direction to prices, soared in October on the Fed's signal that it plans to keep borrowing costs higher for longer well into 2024 in a bid to kill off inflation, still running way above its 2% target.
Just 21% of investors believe the central bank will tighten in December, according to the CME Group's Fedwatch tool. For Kalish, the odds of a hike are "higher than the market's 25% chance, but not more than 50-50."
Bond yields tend to rise in line with interest rates, because bonds' fixed returns become less appealing to investors.
Kalish backed up his assertion that yields of more than 7% are possible by adding together the current 3.4% level of inflation as measured by the Personal Consumption Expenditures index, the neutral rate of interest – also known as r* – of 2.25%, and the term premium for longer-duration debt of 1.65%.
"Add all that up and you get 7.2%," he wrote. "So getting comfortable with a 5% 10-year Treasury is actually quite conservative."