Goldman Warns Central Banks May Unleash "Financial Turbulence, Rate Shock" As It Cuts Yield Forecasts
By Tyler Durden
Every year for the past four, Goldman started off the year with an undauntedly optimism and a bullish forecast, one which usually involved a material increase to GDP expectations and, just as importantly, rising 10Y bond yields. And every year for the past four, it took Goldman a few months before it was forced to trim both its GDP forecast and cut its expectations where the 10Y would end the year.
Moments ago 2016 became the latest year in which Goldman was forced to admit it had been too bullish if not on economic growth (that too will come) then certainly on inflation expectations, and as the bank’s Francesco Garzarelli admitted moments ago, “we are lowering our bond yield forecasts in the major advanced economies by an average 30-40bp across the forecast horizon. Specifically, we now see 10-yr US Treasuries ending 2016 at 2.40% and 2017 at 2.75%, from 2.75% and 3.30%, previously. The corresponding new forecasts for German Bunds are 0.50% and 1.00% (compared to 0.60% and 1.00% previously), and those for JGBs are 0.10% and 0.30% (from 0.30% and 0.60% before). Exhibit 13 at the end of this document summarizes the forecast changes.”
Why the cut? Because after the bank was finally forced to throw in the towel on its wrong 3 rate hike call last week, it no longer has a catalyst to push a strong inflation agenda. Here’s Goldman:
Our new projections reflect (i) a downgrade in the profile for Fed Funds rates announced by our US team last Friday (2 further hikes in the remainder of this year, followed by a further 3 next year, compared with 3 and 4 previously); and (ii) the ongoing absorption of duration risk by the ECB and particularly by the BoJ, delivered in conjunction with negative policy rates.
In other words, much slower growth than Goldman had originally expected, coupled with more central bank intervention and frontrunning of bond purchases, coupled with yield differentials between Europe and Japan where the central banks are actively soaking up all available Treasuries, and the US where for the time being there is no QE.
The forecasts conservatively assume that the current deviation from our Bond Sudoku valuation framework (between 1.5 and 2.0 standard deviations from ‘fair’) will be slowly corrected over the forecast horizon to one standard deviation over the next 6-9-months and close to half a standard deviation by end 2018. We reiterate our view that yield levels below 1.75% in 10-yr US Treasuries (a two standard deviation event) are unlikely to be sustained unless the macro outlook deteriorates materially.
Translation: expect the 10Y to drop below 1.75% on very short notice.
Of course, Goldman does not want to admit that it is wrong (as in the case of its EURUSD parity call), but rather that the market is, well, broken, and provides the following chart to explain why that is the case:
US Treasuries Are Close to 2 Standard Deviations Expensive Relative to Their Fair Value
Well, if they are so “expensive” maybe central …read more
