Goldman Slashes Global Bond Yield Forecasts; Expects Inversion In Front End Of Curve
In the latest admission by Goldman that its economic outlook was, as usual, unrealistically sunny, one day after the bank took down its oil price forecasts, overnight Goldman Sachs also slashed its global bond yield forecasts to reflect “material weakness in growth data, combined with poor risk sentiment and tighter financial conditions.”
This comes alongside a new revision in the bank’s rate hikes for 2019, which it now sees at just 1.1 on a “probability-weighted basis”, down from 4 as recently as a month ago, to wit:
Since their recent peaks last October, global yields across G10 economies have seen a marked decline, with 10y yields declining by anywhere from 15 to 70bp. Much of this has coincided with a sharp drop in equities, suggesting a material reassessment in the growth outlook next year. To be sure, our economists had already expected a somewhat tepid pace amongst major non-US economies, but recent activity data out of China and Europe have been weaker than expected. We have also had reassessments elsewhere. Our US economists have revised down growth forecasts for the first half of 2019 from 2.4% to 2% (though they continue to expect 1.75% in 2H19). This revision comes on the back of weaker-than-expected data (with our Current Activity Indicator dropping from 3.5-4% last summer to a 2-2.5% range) as well as tighter financial conditions. As a result, our modal funds rate call has also been revised downward, from four hikes next year at the early November publication of our outlook, to two hikes in 2019, and a probability-weighted expectation for the net number of hikes of 1.1
The bank’s new 2019 year end forecasts are lower everywhere, from 15bp lower for German 10y yields (to 0.65%), to 50bp lower for US 10y yields, which the bank now sees inching to 3.00%, down from 3.50% previously. The forecast for Canadian yields saw the biggest revision, down 60 bps to 2.40% yet even the revised forecasts are still considerably above current forwards the bank notes. Goldman also notes that “these point forecasts could prove somewhat unstable, given the elevated level of uncertainty about economic outcomes.” U.K. and Japanese expectations were also downgraded. Goldman revised down its 10-year gilt yield forecast by 25 basis points to 1.85 percent, with Japan’s lowered 12 basis points to 0.1 percent.
“We now believe 10y yields may have peaked for this cycle, though we expect them to head higher, towards 3%, by year end” wrote Goldman strategist Praveen Korapaty. “While we continue to expect flattening and even modest inversion in the front end of the curve, we no longer expect the 5s30s curve to fully flatten.”
Admitting it has little idea what really actually happens, Goldman lays outs a scenario table of its assessment of UST yield and curve behavior “under various combinations of growth and Fed outlooks.” In this framework, recent market behavior is most reflected in the lower left quadrant, where markets appear to anticipate a substantial deceleration in growth and the Fed changes its stance only on a meeting-by-meeting basis. According to the bank, owning nominal bonds at these levels for capital gains would require a belief there will be a further decline in growth beyond the slowdown already expected by economists combined with a Fed that under-reacts.
While this is a possibility, Goldman contends that this is unlikely given the more accommodative tone displayed by the Fed since the New Year, even as the bank suspects that there will be a further softening of the Fed’s tone were there to be a further deterioration in actual data.
That is, we could migrate to the lower right quadrant in Exhibit 7, where the optimal exposure is to be long real rather than nominal rates. What if growth concerns are overblown? This would lead us to either of the upper quadrants, with the common theme here being that breakevens are likely to perform well. Indeed, we suspect this is the most likely outcome; based on this, and other factors we discussed in a previous GMD, we continue to like owning 5y5y US inflation breakevens.
Goldman’s downgrade of yields – and the global economic outlook – comes as global bonds have stormed higher in recent weeks as investors grow concerned about the risk of a global recession, which many now see as hitting in late 2019, while markets have slashed their forecast for rate hikes in the US and Europe, and no longer expect any additional tightening by the central banks.
Below is a full summary of Goldman’s latest G10 yield forecasts.