US 10-year yields heading towards 5%?

This wasn’t supposed to be part of the script. At the start of the year, the idea of ​​a 5% return would have been improbable. It all depended on how many rate cuts the Fed was going to make. At the time, markets were debating six or even seven rate cuts. Yet today we are debating the possibility of just one rate cut this year.

This has led to a massive sell-off in bonds over the past few months, with a recovery in April in particular. We went from March to June, then September, and now perhaps November, to the prospects of the Fed’s first rate cut. And this is the main reason for the rise in yields during this period.

With 10-year yields hovering near 4.70% ahead of the Fed’s yields later today, a crucial question is whether they have the potential to move back up to 5%.

Goldman Sachs calls this the pain threshold for stocks in its latest note:

“While there is no “magic number,” historically, bond yields around 5% are when higher yields become a clear problem for stocks – that’s when the correlation with bond yields is no longer decidedly positive.”

So what would it take for yields to rise decisively from here?

Given that traders are still roughly forecasting a rate cut for the year, that means going back entirely. For this to happen, I would say we would need a more hawkish Fed. The key word being warmonger. In this sense, even a less dovish Fed may not be enough to allay this conviction.

In other words, the answer to this question is that the Fed is eventually considering rate hikes.

Right now, I don’t think we’re at that stage yet. But as long as Powell keeps the door open, traders could easily use him to do something more. As such, even the slightest sign of a possible further rate hike by the Fed would be more than enough. However, I would be surprised if Powell offered it later today. My view is that the Fed is not that still desperate.

But if prices continue to hold up in the coming months and the U.S. economy continues to function as it is, that will certainly increase the odds.

And if yields remain supported, this will keep the dollar in favor, with USD/JPY remaining particularly supported. And that’s not quite what the BoJ would like to see happen, especially given that Japan’s inflation trend hasn’t been in its favor lately.