Well, Goldman has seen enough.
On the heels of December’s bond rally and amid rapidly proliferating global growth concerns, the bank is out slashing its year-end forecasts for G10 bond yields.
This looks like a kitchen-sink-ish reappraisal, in line with the bank’s recent downgrade of the US growth outlook and concurrent reappraisal of the Fed path for 2019.
While Goldman still sees 10-year Treasury yields moving higher to 3% by the end of the year, they now “believe 10y yields may have peaked for this cycle”, which the cynical among you will doubtlessly characterize as a contrarian indicator.
After flagging the precipitous decline in yields from the October peak, Goldman notes the obvious, which is that the coincident selloff in equities “suggests a material reassessment in the growth outlook next year.”
With the Fed having now adopted a more cautious stance (“not on a preset course”, “listening to markets”, etc.), and considering the sheer magnitude of the damage not just to risk assets themselves, but also to sentiment, Goldman “expect[s] recovery will be slow, and that markets will be reluctant to price rapid policy normalization, even on a rebound in data.”
“Having telegraphed greater caution, central banks are likely to take time to revert back to a proactive approach”, they go on to write.
Obviously, the decline in yields is down to collapsing breakevens and the generalized “bleeding” of the reflation narrative as exacerbated by plunging crude prices.
“Real yields since late October have held up pretty well [while] inflation breakevens on the other hand, have dropped sharply”, Goldman notes, referencing the charts below and adding “the drop in inflation breakevens has a global flavor to it [and] such moves have typically coincided with a sharp decline in crude oil prices.”
We’ve been over all of that before, most poignantly last week when we took a quick look at the breakdown of 2-year US yields since October.
“Exhibit 5 shows that front end real yields remain substantially elevated relative to the rest of the curve suggesting markets believe central banks are simply too restrictive and decide to remain that way”, Goldman flatly
After diving into a lengthy (and highly interesting for those who are so inclined) strategy discussion, Goldman gets to the new forecasts. Here, we’ll let them tell you about it:
We now expect US 10y yields to end 2019 at 3%, a full 50bp below our previous projection. Comparable numbers for Canada are 2.4% for YE2019, 60bp below previous levels. Changes to our yield forecasts for other large developed market economies are more modest: our YE2019 forecasts for Germany, UK, and Japan are 0.65%, 1.85%, and 0.1%, which are only 15, 25, and 10bp below our previous forecasts.
As far as the US curve goes, Goldman still doesn’t see it flattening entirely by the end of the hiking cycle and it’s also worth noting that the above forecasts suggest US spreads-to-core EUR rates have likely already summited (and “just” a year too late for Bill Gross).
Ultimately, this call marks a kind of capitulation on the growth outlook, although Goldman generally frames it as a recognition of market sentiment rather than a recognition of reality – you’ll note that markets became detached from economic reality in December. The problem, though, is that the longer that detachment persists, the more scope there is for it to become self-fulfilling. That’s something we’ve been pounding the table on for two months.
In any case, take all of the above for what it’s worth and again, note that from where Goldman is sitting, we’ve probably seen the peak in 10-year yields for the cycle.
We’ll leave it to the cynics to determine whether that is in fact a contrarian indicator and we would remind readers that the same people who will say Goldman has just effectively called the bottom for 10-year yields will invariably be the same people who, two months ago, were shouting that banks should revise down their global bond yield forecasts in light of growth concerns. But hey, the peanut gallery will be the peanut gallery, right?