Bond yields could hit 6% as the Fed is going to keep hiking rates until something breaks, research firm says

• Key bond yields are likely headed to 6% as the Fed will keep hiking interest rates, TS Lombard said.
• The research firm pointed to the hot labor market, which could stoke inflation.
• Yields on the 10-year US Treasury have notched a 16-year-high in recent weeks

The 10-year US Treasury yield is headed to 6%, as the Federal Reserve is likely to raise rates until something breaks in the economy, according to research firm TS Lombard.

"Is a 6.5% funds rate and a 6% on the 10Y on its way? Very likely," the firm's chief US economist Steven Blitz wrote in a note on Friday, implying a more than 100 basis-point increase in the Fed's benchmark rate and the 10-year Treasury yield.

That's due to recent robust economic data, which could influence the Fed to take interest rates higher. US production remains strong, with the ISM's Production Index surging 2.5 percentage points through the month of September. The labor market is also still burning hot, with the US adding a staggering 336,000 new jobs last month, above the expected 170,000.

That's the opposite of what markets have been hoping for. Investors have been looking for the economy soften, which would likely influence the Fed to pull back on rate hikes. Officials raised rates 525 basis-points over the last year to lower inflation and cool economic growth, a move that has weighed heavily on stocks.

Markets see a 29% chance Fed officials hikes rates another 25 basis-points in November, up from 20% on Thursday, according to the CME FedWatch tool.

Higher rates risk sparking a recession, especially considering interest rates are already higher than Fed officials think, Blitz said. Using the Taylor Index – an economic formula that calculates interest rates based on target inflation, the neutral rate of the economy, and other factors — Blitz estimated that interest rates in the economy could actually be around 5.75%-6.75%, above the official target range of 5.25%-5.5%. 

"Is the Fed convinced on this point? Probably not, so they will do what they always do, hike until something breaks – and rates are finally at the point where something can be broken," he warned.

Markets have panicked in recent weeks as investors try to adjust to a higher-for-longer interest rate environment. Yields on the 10-year US Treasury just rose to their highest level since 2007, briefly touching 4.8% on Friday.