It has been a day of capitulation for Goldman. Just hours after the bank that controls the White House cut its forecast for Trump tax hikes by nearly 50% from $1.7 trillion to $1.0 trillion, moments ago Goldman, which starts off every single year predicting that 10Y yields will rise to 3.00% (or higher) over the next 12 months – much to our recurring mocking every single year – just cut its 10Y Treasury yield forecast for the end of the year. To be fair (to those who lost money listening to its reco) it did so kicking and screaming, with chief GS Intl strategist Francesco Garzarelli adding saying that “in relation to expectations around nominal activity growth and credit expansion, 10-year bonds now screen as expensive across the board.”
Well, maybe relative to Goldman’s expectations for nominal activity. Others, which as of today also include Fed’s Bullard, however are watching the chart below and have realized that any hopes for an economic rebound in the remaining 7 months of the year are now long gone.
The highlights from Goldman’s capitulation:
Bond bears have had a difficult start to 2017 as a combination of weakening inflation trends and increasing political risks has kept a lid on yields. Reflecting some added uncertainty on the US macro outlook, we are lowering our 2017 year-end forecast for 10-year Treasury yields by 25bp to 2.75% and making smaller adjustments to the other major markets in the same direction.
Our analytics suggest that the main driver of bond returns in recent months has been swings in term premium, and that expectations of short rates have remained fairly stable. In relation to expectations around nominal activity growth and credit expansion, 10-year bonds now screen as expensive across the board.
Looking ahead, our US Economics team continues to project a higher trajectory for Fed Funds than priced into the forwards. Expectations on the path for short-term rates in countries outside the US remain at historical lows, with markets discounting negative real rates for a very long time. The bar for positive surprises therefore does not seem particularly high to us.
Although term premium in the major markets has increased since last November, it remains very depressed by historical standards, reflecting the excess demand for bonds generated by QE policies and the spillover effects that these have across integrated capital markets. As these policies are phased out, term premium should return even if the expected path for short rates does not change much from present low levels.
Goldman’s full revised forecasts below:
Our New Bond Forecasts Are Lower, But Still Above the Forwards
10-year government bond yields, actual, GS forecast, Sudoku macro fair value and market forwards. Spot reflects current (19 May 2017) market yields.
And yet despite admitting that for the 7th consecutive year Goldman’s bearish bond forecast was wrong, it refuses to fully capitulate as it explains in the conclusion:
First, the only bond market where there has been a genuine and sustained increase in rate expectations is the US. These expectations have not changed this week following concerns around the political outlook – the recent decline in yields appears to reflect entirely a further drop in the term premium. Elsewhere in the main advanced economies, however, the expected medium-term path for policy rates is at best stable and at very low levels – i.e., well below the 2% target inflation rate of central banks. In spite of the improvement in economic prospects, the market is discounting negative real rates to remain in place for a very long time across Europe and in Japan. With monetary policy divergence already well established across the major economic blocs, the market risk is skewed in the direction of a convergence of short rate expectations, rather than a continuation of de-coupling.
Second, since the start of this year, bond returns in the major markets have been mostly driven by a realignment in the term premia. Through their QE programmes, European and Japanese central banks continue to actively underwrite duration risk, depressing long-term yields in both their domestic markets. Once the term premium on US Treasuries had risen above that in their main high-rated peers, a valuation gap opened up that made the long end of the Dollar market attractive to global investors on a currency-unhedged basis. The increase in term premium in the Euro area over recent months could be tied to growing expectations that – with the Euro area economy performing better – there will be a gradual unwind of QE during 2018, as discussed further below.
Third, we have now reached a point where expectations on the path for short-term rates in countries outside the US are at historical lows, the term premium is at its most depressed level since the Global Financial Crisis and, reflecting these considerations, government bond valuations are stretched across the board. Barring evidence that the cycle is taking a turn for the worse – which we do not believe – the direction of travel for bond yields in the main advanced economies seems to us to be upwards. Reinforcing the argument, investor positioning in US Treasury futures has swung from very bearish to the most bullish it has been in 3 years, judging by data collated by the CFTC.
Sure, whatever you say: on days like today, we are far more willing to take even chronically wrong jokers like James Bullard who again hinted at more QE (and thus negative real rates) far more seriously, than a Goldman which no longer even is able to control its former employees comprising Trump’s “circle of trust.”
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