Investing.com -- The 10-year Treasury yield’s recent flirtation with 5% sent shockwaves through markets , but economists at BofA believe the bar is high to scale this level as it would require expectations for U.S. economic re-acceleration and Federal Reserve rate hikes.
"More practically, we expect the market will struggle to price 10y UST meaningfully above 5.25%. This outcome would require expectations for US economic re-acceleration, several Fed hikes, and limited negative feedback from risk assets," BofA said in a note.
It isn’t easy, however, to make a case for rate hikes as the Fed sees current stance as "restrictive and ’only’ took back 100bp of 525bp hikes (19% reduction)," the analysts said.
A pivot to hikes is not unprecedented. During 1994 to 1995, the Fed took back 75 basis points hikes out of 300bp, representing a 25% reduction, but "today’s smaller recalibration means less need for hikes," they added.
While inflation continues to trend above the 2% target, CPI inflation now at 2.9% and the Fed benchmark rate at 4.3%, suggest the real policy rate when adjusted for inflation is around 1.4%, which is "tighter than would be required to tame inflation based on that historical precedent," the analysts said.
At the other end of the extreme, a hard landing scenario would force the 10Y Treasury yield to retreat to a range of 3% to 3.25% as the Fed cuts deeper to cushion the economy.
Still, under the more probable scenario, where the market prices in residual cuts or a Fed on hold, BofA expects the 10-year Treasury yield to remain below 4.83%. That is in-line with the BofA’s year-end target for the 10-year Treasury yield of 4.75% and its conviction to fade moves above 5%.
"We think 10Y rates around 5% would be an attractive buy assuming CPI remains sticky or a little lower," the analysts said.