Central Banks Shifting

Shifting from Quantitative easing to Quantitative tightening is unlikely to be smooth Source: ISI

Interest Rate Risks

How high, then, might Treasury yields go? Let’s put together the pieces. Supposed the Fed’s short-term interest-rate target, adjusted for inflation, averages about 1% over the next decade. Inflation averages 2.5%, and the bond risk premium is one percentage point. In sum, this suggests a 10-year Treasury note yield of 4.5%. And that’s a conservative estimate: Given historical neutral short-term rates, the recent persistence of inflation and the troubling US fiscal trajectory, all three elements could easily go higher.

To some extent, this is what the Fed needs to happen, to slow the economy and get inflation under control. That said, it’s been so long since long-term rates have reached such heights that further havoc is all but guaranteed. There’s just one possible silver lining: With any luck, a reawakened bond market might force US politicians to finally get the country’s fiscal house in order. The sooner the better.