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Goldman Reiterates It Is Bearish On Bonds, But For The Wrong Reason

Tyler Durden's picture


Following the risk aversion rally in bonds over the past month, as a result of the increasingly jittery outlook on stocks, many dealers have had to realign their positioning in the rates arena. And while some who have an outright short exposure on the fixed income market such as Pimco attempt to downplay their bearishness for fears of how LPs will react, others like Goldman are becoming increasingly more vocal in their bearish bias to fixed income. In a note released overnight Goldman's Francesco Garzarelli repeats that the firm which does god's work continues to be negatively inclined toward the treasury prices, reiterating its 10 year forecast (3.50% and 3.75% for 10-yr USTs by end-June and end-December), although not due to structural considerations such as the US being technical insolvent if not practically so (for the time being the US is more than capable of paying its interest expense out of collected tax revenue) but due to the ongoing false impression that the economy is improving. In short, due to still strong (and soon to be revised lower) forecasts on US GDP, coupled with increasing inflation expectations, Goldman urges clients to be short here: "Consistently, we would treat a further decline in intermediate to
longer-dated yields as an opportunity to recommend short positions
again." So while in the long-run Goldman is likely correct, it is for the wrong reasons. The right one, naturally, continues to be the latent threat of fixed income rumblings manifesting themselves via the latent bond vigilantes finally moving away from Europe and shifting their attention to the insolvent US. With the Fed shifting away from its position of structural support in the fixed income market following June 30's end of QE2, the economy will once again be in uncharted territory especially with a record amount of bonds needing to find willing buyers over the next 12 months. On the other hand, with GS clients urged to sell bonds, that means that as usual Goldman is buying, so take the typical reverse psychology approach to any Goldman call with a grain of salt.

From Goldman Sachs, Capped Upside for Bonds

Fixed-income markets have extended the rally in place since mid-April, with US Treasury yields now setting fresh lows for the year. On the back of lower commodity prices, the term structure of inflation has lowered and steepened from the front-end, while real rates remain depressed. Year-to-date total returns on 7-10-yr US T-notes are now around 3.0%, outperforming the European markets and Japan. Australian bonds – our ‘top pick’ –have posted the highest period returns among the majors. Weaker-than-expected economic data, including wage growth, continue to support our relative preference for AUD fixed income.

We retain a bearish strategic bias on market direction, consistent with our expectation of a rebound to above-trend GDP growth in H2:11 and a further increase in core inflation. Our forecasts for USTs are 3.50% and 3.75% for 10-yr USTs by end-June and end-December (spot: 3.13%). The corresponding numbers for German Bunds are 3.30% and 3.50% (spot: 3.1%), and 1.3% and 1.6% for JGBs (spot: 1.1%). These forecasts are higher than the forwards particularly in Euroland and Japan.

Our tactical views are informed by the following considerations:

  • Yields have mirrored the relative decline of cyclical stocks in place since March. Over this period, the relationship between our Wavefront US Growth equity basket (which pits cyclicals vs. defensives in the S&P500) and the 2-10-yr slope of the US curve has been relatively tight. If recent patterns continue to hold, the yield curve could flatten by another 20bp to catch-up to where cyclicals currently trade on a relative basis. This would put 5-yr UST yields in the ballpark of 1.50% and the 10-yr in a 2.8-3.0% range. As discussed in yesterday’s Daily, however, we consider the underperformance of cyclical sectors relative to the broader index as reflecting a marked slowing in equity market growth expectations, perhaps somewhat beyond what the data currently indicate. Our price targets for the S&P500 are 1375 by end June and 1500 at year-end although we are mindful that the route there could be more circuitous than hitherto. Consistently, we would treat a further decline in intermediate to longer-dated yields as an opportunity to recommend short positions again.
  • As a cross check, our Bond Sudoku model — which links 10-yr government bond yields to 1-yr ahead expectations on GDP growth, CPI inflation and short rates in the main advanced economies — indicates that 10-yr Treasuries should currently trade at 3.3% and 10-yr Bunds at 3.15%. A breach of the yield levels alluded to earlier (i.e., 2.8% on TY10) would represent a more than 1 standard deviation departure from our measure of ‘fair value’. According to our analytics, the current term structure of rates in the major economies is stimulative. In the US, it appears consistent with negative nominal overnight rates.
  • Admittedly, growth forecasts have been sequentially revised downwards from upbeat levels at the start of the year, particularly in the US. This has been among the main drivers behind the underperformance of cyclicals and steep decline Fed hike expectations over 2013-14. But at the same time, forecasts of core inflation are increasing. In the context of our modeling work for bond yields, recent shifts in these two macro factors (lower growth/higher inflation) broadly offset each other. Feeding the model with our baseline macro projections for this year and next, we find that 10-yr US Treasury and Germany Bund yields should end 2011 at around 3.5%, or above. This is at least 30bp higher than the current year-end forward rate.

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Wed, 05/18/2011 - 09:14 | 1286599 LawsofPhysics
LawsofPhysics's picture

What's that?  Goldman is now buying bonds?  Wouldn't they want to manipulate yields up first?

Wed, 05/18/2011 - 09:21 | 1286642 topcallingtroll
topcallingtroll's picture

Looks like a real call.

But i think they also want people to think they and the obama administration are not one and the same.

Wed, 05/18/2011 - 09:01 | 1286603 hugovanderbubble
hugovanderbubble's picture

Blankfein should be in jail for ever.

Paulson and Geithner and Greenspan.


Goldman Sachs has crashed the world with HSBC and JPMorgan...



Wed, 05/18/2011 - 09:22 | 1286643 rocker
rocker's picture

+1   When will Congress, DOJ or the SEC investigate and prosecute this crook.

Wed, 05/18/2011 - 09:27 | 1286665 Careless Whisper
Careless Whisper's picture

CDS Short Squeeze, GoldmanSachs style (from an internal email, courtesy Senator Levin - page 426)

We should start killing the sn [single name] shorts in the street – let’s pick some high quality stuff that guys are hoping is wider today and offer protection tight – this will have people totally demoralized.”1743

Wed, 05/18/2011 - 09:01 | 1286604 topcallingtroll
topcallingtroll's picture

I guess they are trying to prove their independence of the government.

Wed, 05/18/2011 - 09:19 | 1286639 bigdumbnugly
bigdumbnugly's picture

well that convinces me!



Wed, 05/18/2011 - 09:06 | 1286617 oogs66
oogs66's picture

we must be about a week away from one of their strategists calling a sell on stocks and spooking a flight to quality trade :)

Wed, 05/18/2011 - 09:15 | 1286636 bigdumbnugly
bigdumbnugly's picture

that's been the roadmap...

Wed, 05/18/2011 - 09:13 | 1286628 Johnny Lawrence
Johnny Lawrence's picture

The great contrarian trade...tin foil hats and the big brokerage firms are all bearish on bonds.

Wed, 05/18/2011 - 09:15 | 1286637 Hondo
Hondo's picture

Sounds like Koo's explanation.  Now besides low interest rates the minions of the FED are trying to force investors out of Treasury's into risk assets at an alarmist pace.  Will the FED be able to continue the liquidity game long enough to totally and with finality steal the wealth of investors??

Wed, 05/18/2011 - 09:22 | 1286645 Boston
Boston's picture

On the other hand, with GS clients urged to sell bonds, that means that as usual Goldman is buying, so take the typical reverse psychology approach to any Goldman call with a grain of salt.

Bingo!  Makes me feel better about being long.

A breach of the yield levels alluded to earlier (i.e., 2.8% on TY10) would represent a more than 1 standard deviation departure from our measure of ‘fair value’.

Funny, that's exactly my first target to start exiting my Treasury longs.  But it'll take a much bigger, and prolonged Risk-Off period to get there.  I'm thinking June-August, almost mirroring last year's bearish phase.

Wed, 05/18/2011 - 09:25 | 1286652 ivana
ivana's picture

ha ha told ya!

Now wait for soros to become "bullish" on bonds

Wed, 05/18/2011 - 09:26 | 1286654 Dr. No
Dr. No's picture

With the treasury raiding pensions, is this bullish for bonds?  By raiding the pensions, the Treasury no longer needs to sell bonds.  A huge supply source is gone.  Is this true?  If they FED maintains it current rate of purchase, this should be a bump in prices.  If the FED cuts back, this will be bearish for stocks.

Wed, 05/18/2011 - 09:55 | 1286766 4shzl
4shzl's picture

Short Treasuries = widowmaker.  Just ask the wise guys who've been shorting the JGB for the last decade or two.

Wed, 05/18/2011 - 10:20 | 1286851 buzzsaw99
buzzsaw99's picture

When the squid speaks, people :roll:

Wed, 05/18/2011 - 10:34 | 1286949 belsebub
belsebub's picture

What does LP mean?

Wed, 05/18/2011 - 13:40 | 1287914 TempFlashback
TempFlashback's picture

Limited Partnership

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