Here's my take on what would happen to Treasury yields if there were a default: Initially yields would spike across the entire Treasury curve. How much is anyone's guess. On the long end, I could envision a move in the 30-year to the 4.75% to 5% range and the 10-year to the 3.75% to 4% range. There would quickly be an inversion at the front end of the curve and the longer end of the curve would settle down very quickly as Congress, completely horrified by the consequences of what was allowed to happen, realizes it made a big mistake and works to correct it. In the end, bondholders would be made whole (not sure how money markets that broke the buck would handle things), but it would not change the effects to the markets (except the Treasury market). As soon as the possibility of a Treasury default becomes a reality, Treasuries (especially bills), which are currently a major form of collateral in the world's financial system will be viewed and priced (from a haircut perspective) differently. It would cause so much havoc in the shadow banking system/swaps markets/derivatives markets that major margin calls would work their way through the financial system. Stocks, commodities (except gold and maybe silver), and corporate and muni bonds would all sell off dramatically. I don't know what plan the Fed would come up with to try to provide liquidity to the markets. I suspect the Fed might be forced to put an explicit cap on Treasury rates (saying it would buy every single Treasury above a certain yield).
As all this is happening, a completely confusing thing (to the financial press) will occur. Treasury yields will start to decline, and decline in a dramatic way. This will occur because at the end of the day, it will still take time to usher in a new reserve currency (the reserve currency needs to be backed by an extremely liquid and deep bond market) and Treasuries, which will still be the major form of collateral in the world's financial system will be needed more than ever as the selloff in other assets intensifies. Plus, there will likely be collateral haircuts applied to Treasuries (because of the initial default, which makes people realize that a default actually can happen), and those haircuts will only intensify the demand for Treasuries as more will need to be purchased to satisfy the same level of collateral needs that used to require purchasing fewer Treasuries.
My apologies for the run-ons and at times not clearly presented thoughts. It's late, and I'm off to bed.
Regards,
The Financial Lexicon
Author of Income Investing Insider