The yield on the 10-year Treasury bill has been going buck wild after bottoming in May.
Today, Deutsche Bank’s Joe LaVorgna has declared the bull market in bonds, which depending on your definition began in the mid-80s, officially over.
After being held to an “artificially-low, central bank-induced level,” he writes in a new note, rates can now only climb higher.
Assuming 4.4% nominal GDP this year, LaVorgna has his model puts the 10-year yield at an average of about 4.1%.
But, LaVorgna says, that’s not likely to happen “because Fed tightening is likely still some time away.”
There also appears to be a natural limit to how high rates can go, he says pointing to the Fed funds rate:
The steepest the 10-year treasury has been relative to the fed funds rate using monthly data has been 385 bps in December 1992. In the last business cycle, the 10s-fed funds spread went as high as 372 bps in May 2004, but this was just one month before the Fed began raising interest rates.
LaVorgna says that in the last two tightening cycles — Feb. 1994 and June 2004 — the spread between 10-years and the Fed funds rate averaged 303 basis points over the preceding 18 months.
That, he says, seems to be the most reasonable benchmark for predicting where yields will go.
“With the fed effective rate around 10 to 15 bps, we estimate that a 300 bp spread puts the fair value on 10s between 3% to 3.25%,” he said. “Ahead of an eventual increase in official interest rates, we expect yields to trend higher over the course of this year—rising to 2.75% and possibly higher.”
Currently, the 10-year yield is at 2.44%.
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