Goldman appears to be in full freak out mode today. After the bank had been positioned for a smooth, low-vol economic reflation mode, complete with long stock and short bond exposure, the recent volatility has blown up Goldman's trades right in its face. Earlier we noted that the FX desk advised on a long EURUSD trade with a 1.50 target following the surge in FX vole. And while it is unclear if the jump in vol across all risk assets is enough to cripple the bank like it did in May 2010 when Goldman disclosed massive trading losses on its variance swap trade, the bank appears to have suffered some major damage on its treasury curve exposure following the recent tightening. As a result Francesco Garzarelli has just released a trade update, advising clients to go short the 5 Year at 1.936% with a 2.30% target and a stop at 1.80%. As usual, since that would mean Goldman is now accumulating 5 Year inventory, it appears we will soon have a rather dramatic duel between the two biggest Wall Street titans: PIMCO and Goldman, at least as pertains to their outlook on rates.
From Goldman Sachs:
Trade Update: Go Short 5-yr US Treasuries, as Yields Price Excessive Growth Damage
Escalating geopolitical risks in the Middle East and North Africa, coupled with the most recent devastating events in Japan, have pushed global bond yields considerably lower. The combination of more hawkish European central banks and greater flight-to-quality flows being channelled into the Treasury market has meant that US Treasuries have considerably outperformed their European counterparts. The 5-year sector has outperformed in this rally, despite the fact that real rates are already very low and that growth expectations matter relatively more than for longer durations.
Meanwhile, US economic data over the same period suggest a less friendly inflation-growth mix for US rates. In particular, business surveys are now consistent with GDP growth of well above 4%, while core inflation has continued to edge higher.
To be sure, we still see core inflation staying close to 1% for the foreseeable future and we expect the Fed to remain comfortable with the inflation outlook, given the very high degree of economic slack. But the fact that US rates have rallied strongly, to well below our near-term forecasts, and against the grain of recent macro data, offers a good tactical opportunity to pay rates. We recommend going short 5-yr US Treasuries at 1.936% for a potential target of 2.30% and a close below 1.80%.