Goldman Sachs's Big Bond Call Is Just Bluster. Again.

Goldman Sachs Group Inc. is at it again in the world’s biggest bond market.

That was my immediate thought when I saw the Bloomberg News headline, “Goldman Goes All-In for Steeper U.S. Yield Curves as 2021 Theme.” The firm’s year-ahead investment outlook recommends that traders position for longer-term Treasury yields to rise on expectations for real growth and inflation, while the Federal Reserve pins down front-end rates near-zero. That’s sensible — and borderline consensus at this point — but just how far do the strategists expect this trade to go? 

Goldman forecasts that 10-year Treasury yields will reach 1.3% by the end of next year, from about 0.96% now. Meanwhile, they foresee two-year yields just inching up from their present 0.18% level to 0.25%. That means the bank sees roughly 30 basis points of steepening for the 2- to 10-year curve -- now at about 78 basis points.

That forecast feels like a letdown. Just consider the historical context: A 1.3% 10-year yield would have been an all-time low as recently as late February, before the coronavirus pandemic roiled financial markets. A gap of 105 basis points between two-year and 10-year Treasury yields would still be less than at any point from early 2008 through the end of 2015. Even starting from the beginning of 2020 — when the spread between two-year and  10-year U.S. notes was just 34 basis points, a 71-basis-point widening is still paltry in comparison to other bear-steepening episodes like 2009.

Goldman Sachs's Big Bond Call Is Just Bluster. Again.

If this feeling seems familiar, it’s because right around this time a year ago, Goldman strategists put out a flashy forecast for a 2020 “baby bear market” in bonds. I wrote that such phrasing hid an otherwise mundane call for the benchmark 10-year Treasury yield to climb to 2.25% from slightly less than 1.8%, with the increase “mostly skewed toward the second half of 2020.” Obviously, the Covid-19 pandemic wreaked havoc on that prediction, which was otherwise in line with market expectations for the Fed to leave interest rates steady.

Still, as I noted at the time, even if Goldman’s forecast for 2020 played out, it would have spelled a loss of just 1.9% for 10-year Treasuries and 1% for the broad Bloomberg Barclays U.S. Treasury Index. That made tossing around the term “bear market,” which has a traditional definition of a decline of 20% or more over a sustained period, seem hyperbolic.

The same kind of analysis holds true for Goldman’s 2021 call. A 35-basis-point increase in the 10-year yield from now until the end of 2021 would mean a loss of about 1.6% over the period, while a seven-basis-point move higher in two-year yields would net investors a positive 0.13% total return. A quickly steepening yield curve can often mean large losses for Treasuries as a whole, given that the prices of longer-term securities are more sensitive to swings in interest rates. The scenario laid out by Goldman, in effect, looks like just another edition of a “baby bear market.”

Again, much like a year ago, there’s nothing outlandish about predicting a steeper yield curve. The Fed’s new monetary policy framework calls for inflation to average 2% over time, which gives the central bank cover to leave interest rates near zero even when it modestly overshoots that target. It’s still an open question whether policy makers can talk the U.S. economy into inflation, but such price growth can’t be ruled out in the year ahead if the Fed keeps its foot on the gas and a potential coronavirus vaccine encourages a return to pre-pandemic activity across the country. The central bank likely wouldn’t push back much on higher long-term rates if they’re rising because of better-than-expected economic growth. 

But it would be a mistake to assume that the Treasury market is on the verge of a rapid repricing. As Bloomberg News’s Stephen Spratt reported on Tuesday, there’s already ample evidence of a tug-of-war among traders about which way yields will move next, even with the benchmark 10-year rate threatening to breach 1% for the first time since March. If it reaches that level, Mizuho International Plc says 10-year notes are a buy. Yet, at the same time, one measure of outstanding positions in 10-year Treasury futures suggests some traders are building large new shorts.

It all adds up to another mundane outlook for Treasuries in the year ahead, even if the world has dramatically changed in the past 12 months. After a roller-coaster 2020, a period of relative tranquility probably sounds pretty good to fixed-income investors. 

This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.

Brian Chappatta is a Bloomberg Opinion columnist covering debt markets. He previously covered bonds for Bloomberg News. He is also a CFA charterholder.

©2020 Bloomberg L.P.

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