Ned Davis Research from Reuters

By David Randall

NEW YORK (Reuters) – Investors should brace for the possibility of long-duration Treasury yields reaching 7% if the U.S. economy manages to avoid a forecasted recession, according to a report from Ned Davis Research released on Tuesday.

Currently, benchmark 10-year Treasury yields linger around 5%, near their highest levels in 16 years, as investors react to increasing U.S. federal deficits and the Federal Reserve’s indication that it plans to maintain higher rates until inflation is deemed under control. This decline in Treasury prices has negatively impacted stock market valuations and raised borrowing costs for both businesses and consumers.

Joseph Kalish, the chief global macro strategist at Ned Davis Research, noted that the sell-off in Treasuries might persist if the neutral rate of interest – the point at which monetary policy neither stimulates nor restricts economic growth – increases due to an extended economic expansion.

As measured by the PCE price index, inflation rose 3.4% in September compared to the same month last year, slightly above its 3.3% average since 1960. Kalish indicated that the neutral interest rate, also known as r-star, appears to be above the 2% benchmark.

When factoring in a term premium for longer-dated debt, which averaged 1.65% pre-pandemic since 1961, Kalish calculated a potential yield of 7.20%. He remarked, "Thus, feeling comfortable with a 5% 10-year Treasury is relatively conservative."

In light of the likelihood of worsening conditions in the Treasury market, Kalish expressed a positive outlook on gold investments while remaining slightly underweight in bonds and preferring large-cap equities over small-caps.

The firm does not anticipate the Federal Reserve will increase its benchmark rate during its upcoming meeting concluding Wednesday and estimates a 50-50 chance of one additional rate hike before year-end, as Kalish explained. "Powell will want to affirm that another hike is still on the table," he added.

In terms of market expectations, Kalish suggested that the Treasury Department’s upcoming refunding announcement is unlikely to significantly influence markets, as it will probably reiterate Treasury’s commitment to a consistent and predictable borrowing schedule. "Don’t look for anything dramatic," he cautioned.