We believe there is a reasonable possibility for 10yr UST yields to dash to 4.5% levels in CY26. Our own sense is we will finish CY25 for 10yr USTs at 4.15% & 4.25% in CY26. But in this opinion piece we explore various factors which can pull 10yr UST yields towards 4.5% levels from current 4.1% levels. The key drivers would be a hawkish shift in Fed expectations or fiscal fears but a combination of the two would likely be required. For the 10Y to reach 4.5% purely via the Fed pricing channel would likely require no rate cuts beyond Dec cut and the market to start viewing the next policy move as more likely to be a rate hike. If the fed funds target range is at 3.50-3.75%, then 1Y1Y USD OIS is likely to be around 3.60- 3.65%. Based on the relationship between 1Y1Y and the 10Y yield so far this year, that would push 10Y to around 4.45%. This will require a mix of strong growth & elevated inflation in US. This could be quite realistic as US productivity growth is the highest amongst all DMs. There is a significant potential for a further late-cycle pick-up in US productivity growth and historically such a productivity surge tends to go hand-in-hand with solid job growth. We believe the U.S. is on the cusp of another surge in labor productivity that should drive greater economic efficiencies, boost real wages, expand corporate profitability and maintain America’s global competitiveness relative to the rest of the world. if a high growth scenario emerged in tandem with still-sticky (or even rising) inflation, then the market would need to pivot towards pricing in rate hikes, and possibly also a higher r* (natural rate of interest) which would likely boost long-term real yields. We also believe soon there will be a flare up in the term premium demand for long end USTs. The 10Y term premium remains c.100bps below its long-term average, suggesting further upside potential. We list several factors such as US Supreme Court ruling out Trump's tariffs, Trump's recent talk of tariff dividends to the tune of $2000, UST likely increase in dated supply by end CY26, pressure from EURO rates due to Dutch pension reforms as well as higher German fiscal spending, pressure from JGB rates due to fiscal expansion as well as rate hikes leading to repatriation of UST investments to JGBs & the latest Hassett factor. Kevin Hassett selection might imply loss of institutional credibility for Fed considering his well known stance on rate cuts. This might further push inflation expectations higher as well as term premiums. Hence we conclude that It is entirely possible that 10yr USTs test 4.5% in CY26 based upon a host of factors as highlighted above. The risks to the above view is a sustained fall in crude towards $50 levels OR AI theme suddenly breaking down leading to a severe risk off. We believe as a prudent risk management tool, we should be cognisant of duration risk in light of above factors.
