Wall Street institutions warn: The Federal Reserve has committed the "original sin," and the yield on the 10-year U.S. Treasury bond may approach 8%

Author: Zhao Ying, Wall Street Journal

As the global bond market storm intensifies, TS Lombard's Chief U.S. Economist Steven Blitz warns that the Federal Reserve may repeat historical mistakes by prematurely easing monetary policy before inflation is fully suppressed. This "original sin" could drive the yield on the 10-year U.S. Treasury bond to ultimately reach 8% in the coming years.

The yield on the 10-year U.S. Treasury bond rose to 5.30% on Wednesday, reaching a new high since 2002, and most institutions on Wall Street are discussing whether 6% is the next threshold. However, Blitz believes in his latest report "Original Sin Replayed" that this judgment is "too narrow"—5.75% is merely the next phase platform, while 8% is the long-term target, which will significantly suppress the stock market and end the "buy the dip" mentality that investors have held for decades.

The core logic of this judgment lies in the combination of loose fiscal and monetary policies, which will raise the central tendency of inflation and yields in every economic cycle, while the political ecology in the U.S. makes it difficult to reverse this situation in the short term. Blitz clearly states that the political will to genuinely suppress inflation in the U.S. may not emerge until 2029, "but I wouldn't bet on that."

"Original Sin": Premature Easing, History Repeats

Blitz defines the "original sin" of monetary policy as prematurely easing before the economic downturn has sufficiently eliminated inflation, "like taking another bite of the same apple."

In his narrative, the "perpetrator" this time is former Federal Reserve Chair Jerome Powell. At the end of last year, faced with a cooling job market but a rebound in corporate profits, Powell chose to cut interest rates—Blitz points out that this decision happened just two months before the 2024 presidential election, objectively providing a political gift to the Biden administration at that time. Blitz acknowledges that Powell faced "immense pressure" from the government and several individuals eyeing his position, including some members of the Federal Open Market Committee (FOMC), who wanted Powell to "close his eyes and ease more."

Now, figures like Trump, Treasury Secretary Bessent, and economic advisor Bessent hope that the new Federal Reserve Chair Waller will "execute loose policies with eyes open and closed" during the new upward cycle. Waller resisted with a 25 basis point rate hike at the September meeting, raising the federal funds rate to the 3.75%-4.00% range, with a unanimous vote. Blitz's reaction was: "Why not raise it by 50 basis points?"

"The Nonexistent Recession": Fiscal Expansion Disrupted Adjustment

Blitz characterizes 2025 as "the nonexistent recession." After the yield curve inverted for about 22 months, private non-farm employment, excluding the healthcare sector, has been declining, and real economic growth should have contracted, but this situation has never materialized.

The reasons are twofold: first, the scale of fiscal expansion is too large, and second, the Federal Reserve began cutting interest rates just as corporate profits were rebounding. Tariff policies have also played a role in exacerbating the situation.

Blitz cites two classic Wall Street rules: first, corporate profits lead employment, and employment leads inflation; second, the mildest year of inflation is often the first year of recovery. This means that 2026 is a "good year," and under the impact of tariffs and oil price shocks, core inflation has actually decreased. However, from now on, if the stock market remains supportive, high corporate profits will drive faster hiring, thereby pushing up core inflation in 2027.

He also points out that the core PCE data for August released this week appeared "below expectations" only because the actual reading of 0.247% was rounded down to 0.2%, and the benchmark revisions artificially lowered the entire series. Meanwhile, super core inflation rose by 0.4% month-on-month, with the "other services" category recording the largest increase in history, and education costs also surged to record highs. The yield on the 10-year U.S. Treasury bond subsequently erased all gains following the PCE data release.

Swap Spreads: The Market is Pricing Fiscal Risk

The most unique part of Blitz's analysis is his interpretation of swap spreads. He believes that the deep driving force behind rising yields is "excess sovereign debt supply"—developed market government debt needs to be rolled over, while the pace of fiscal deficit expansion exceeds nominal GDP growth, and central banks are no longer acting as marginal buyers.

The most direct signal comes from swap spreads: investors are increasingly inclined to receive floating overnight secured rates over a 10-year term rather than hold fixed coupon sovereign bonds. This trend has existed in the U.S. since 2012 but has spread globally after the COVID-19 pandemic—swap spreads in the UK and France have narrowed significantly, and Germany's situation is also tending towards equilibrium.

Blitz emphasizes that this is "a risk appetite issue, not a curve issue." France and Germany share the same central bank, and the Bank of England usually follows the European Central Bank, but the swap spreads in the two countries have diverged. What the market is pricing is fiscal risk, not policy rates or inflation paths.

He established a model for the U.S. 10-year swap spread, and the results show that even after excluding the effects of the yield curve shape and bank balance sheet regulatory constraints, the market's preference for U.S. Treasuries is still declining year by year.

Why 8%: Policy Combination and Political Logic

Blitz's core conclusion is that the combination of loose monetary and expansionary fiscal policies will raise the bottom of inflation and yields in every cycle until there is a genuine political will to suppress inflation at the cost of short-term growth.

He summarizes this divergence as "Hamilton versus Jackson"—the former represents the path of running the economy through a central bank, while the latter represents the path relying on government policy. And "the populism that will elect the next president tends towards Jackson." He encapsulates the past decade of U.S. politics in one sentence: "People are conservative on social issues and liberal on fiscal issues."

The nature of rising yields is also crucial. Blitz points out that so far, rising yields have mainly been driven by real interest rates, which has suppressed the stock market while avoiding a sell-off of the dollar. However, if the driving force shifts to inflation expectation premiums, "the stock market may perform well, and dollar bears will welcome their time," at which point "the long-anticipated dollar bear market will truly begin."

The decisive variable is that the U.S. net savings rate has fallen to zero, with "no signs of improvement." Against this backdrop, Blitz gives his judgment: "Ultimately, we will see the yield on the 10-year U.S. Treasury bond reach 8%."

What Will "Collapse" First

Blitz does not predict the collapse of any specific asset. He expects what will break is a mindset—the market's "firm belief" in inflation returning to 2% and the reflexive logic that "being long on stocks and bonds will always yield returns." For a generation of investors who have experienced 40 years of declining interest rates and are accustomed to buying the dip, this will be a significant cognitive adjustment.

Notably, Blitz is not alone in this view. Reports indicate that Rich Privorostsky, head of Goldman Sachs' delta hedging business, stated this week that the trend in interest rates "has become harsh enough to be unignorable," even though "the stock market has shown impressive resilience."

Moreover, the U.S. Treasury does have an influence on the trend of yields. Rabobank previously referred to the Treasury's expanded bond buyback plan in August as "light version yield curve control" and warned that "higher yields worsen fiscal prospects, thereby increasing term premiums, which in turn raises yields again," and that the buyback operations "interrupt this cycle but may not break it."

Blitz's judgment is that a government that refuses to accept a recession cannot autonomously choose the upper limit of yields.