Goldman's Jim O'Neill On The Consequences Of The 10 Year Hitting 5%

Tyler Durden's picture

Here's a hint: it's all great. Just like the 10 Year hitting 0% was great for stocks, Jim explains why its round trip bacl to 5% is even gooder. In fact, it may be one of the goodest things to ever happen to the gnome underpants business that Goldman suddenly believes the US economy is: "I would guess that GDP growth could be above 3 pct, and it would not surprise me if some start forecasting close to 4 pct soon...checking my simple stats with Jan Hatzius this weekend, the US stock market would “only” need to rise by around 19 pct in order for the 168 bps rise in government bond yields to be entirely neutralized...Are 5 pct US 10-year yields and an S+P of 1475 possible in 2011? We shall see. In my opinion, a 19 pct rise in the US stock market seems quite likely. As for 5 pct bond yields, I think they are much less likely, but not impossible. If they did occur, it certainly wouldn’t have to be for negative reasons." That's all fine and great even if it is totally and utterly insane. The real win here, and it may be hidden at first, is that we now have not a phrase, but an entire essay to challenge that all time dumbest thing ever uttered: "If it weren't for my horse, I wouldn't have spent that year in college"...

From Goldman Sachs Asset Management:


In the past two weeks, we have witnessed a remarkable rise in US interest rates. Those people who are one step removed from the financial markets might not be really notice, however, since the level of interest rates is still remarkably low. But, in the past 2 weeks, the rise across the whole maturity spectrum of US rates has been quite noteworthy. The topic was discussed by John Authers in Saturday’s Financial Times. According to John, 10-year rates rose 14 pct on Tuesday. And, since their absolute bottom on October 7th, they have risen 37 pct. As I shall discuss below, this rise has led to numerous discussions, many of which suggest that the Fed’s so-called “QE2” has not worked. Others suggest that this rise is the work of bond market vigilantes punishing the US ala European style for fiscal excess, and a small number acknowledge, in fact, that it simply recognizes that the US economy is suddenly looking quite a bit perkier. The latter argument is my own preferred one. More on this later, but the fact that shorter term interest rates have risen sharply in my judgment supports this view.

US 2-year note yields have risen from around 0.38 basis points (bps) to around 0.64 on Friday – a near 70 pct increase! Presumably, this part of the yield curve is less vulnerable to pure market forces and more closely related to perceptions of central bank policy over the next 2 years. If this is correct, then I can’t understand why the more negative assessments of rising rates are appropriate.


Of course, none of us really know or never will. There appears to be 4 possible explanations. First, the most abrupt rise happened last week, coinciding with signs of an agreement between President Obama and Congress for an additional fiscal stimulus. Given the underlying fiscal deficit and debt situation, which on a cyclically-adjusted basis appears to be on a par with Portugal, the bears are arguing that the vigilantes are suddenly out in force, expressing their distaste for the wanton disregard of any kind of budgetary discipline in the world’s largest economy and major reserve currency. While this is certainly possible, I am far from sure that it is the case. If it were true, how come the Dollar rose during this period, and US stock indices continue to make fresh highs?

Second, some bears also argue that, possibly related to the first point, it is the beginning of an inflationary surge in the US and the appropriate punishment for the lavish monetary and fiscal stimulus that has been applied to help exit from the severe recession induced by the housing collapse and credit crisis. This seems even easier to refute in my view, as much of the rise in yields can also be seen in “real yields” through the TIPS market, and most measures of inflationary expectations have been quite stable.

A third argument, also possibly linked to the others, is that it is simply recognition that, whatever the state of the economy, there will be no more quantitative easing given the hostility in which QE2 was greeted, both by many politicians domestically and by overseas policymakers. While it is probably the case that the Fed is somewhat surprised by the strength of opposition expressed to their move, my view is that the Fed will judge their future monetary policy needs and obligations by both the actual evidence and outlook for real economic growth, employment and inflation.

The final fourth and quite simple argument is that, “It’s the economy, stupid.” In the past few weeks, with the exception of the November payrolls, most important coincident and lead indicators for the US have improved notably. Of most importance, there has been a sharp improvement in weekly jobless claims, a good guide to underlying unemployment and a pretty good predictor of the stock market. The November manufacturing ISM survey kept hold to much of its previous monthly outsized gains and, towards the end of last week, the October trade report showed a further sharp improvement in exports. If you add the possible 0.5-1.0 pct stimulatory impact of the budget deal, it is looking more and more likely to me that 2011 is going to be an “above trend” year for US real GDP growth. I would guess that GDP growth could be above 3 pct, and it would not surprise me if some start forecasting close to 4 pct soon.

If the latter explanation is conceivable, then this would sit more easily with what has happened to all financial markets, including the stock and foreign exchange market.

I have thought since late September that it was quite possible, even likely, that once the mid-term elections were out of the way, the negative mood surrounding the US might lift. Indeed, I have joked on a number of occasions that everyone I met seemed to think that they had a below consensus view of the US economy. Well, this is no longer the case. And, for those that stick with a negative cyclical outlook, they have got to be hoping that rising US interest rates choke off the budding recovery.


I have 2 completely contrary opinions.

The first, and the one I am assuming, is that in the near term, US rates will not rise much further. I had thought back in September when I first smelled signs of stronger US growth than generally perceived, that if the data started to back me up, then it would be likely that the case for QE3, i.e., even more Fed easing would quickly fade and the US 2-year note sometime in Q1 2011 would get to 0.75. That is now only 11 basis points away, a mere 17 pct! I assumed that 10-year yields might manage 3.50 pct, a mere 18 bps and now just 5 pct away.

If the Fed is conducting policy on what might be referred to as an “output gap” basis, then it is going to take a lot more positive growth before the Fed gives up its recent concerns and those stated reasons which led it into its last monetary easing. While the view will vary depending on individual assumptions of the growth trend, some key Fed officials like Bill Dudley have used phrases like “many years” in describing how long the Fed might have to stick to its current policies.

For the 2-year note to move up to 1 pct and beyond, I think the Fed will need evidence of 5 pct real GDP growth for 2011 before that were warranted. Of course, this strength of GDP growth is not impossible and the next month’s ISM and payroll data are likely to be highly illuminating.

If 2-year notes don’t move much above 0.75 pct, it is tough to see 10-year yields rising much above 3.50 pct unless the darker interpretations from above were the main culprit, i.e., fiscal profligacy and sharply rising inflation expectations.

The second opinion is very different.

Within a couple of weeks of my move into this new exciting phase of my life, I started to spend quite a lot of time wondering about the “consequences” of 5 pct 10-year US bond yields. There are many reasons why this came into my head including that, at some stage in the future, if the US economy returned to normal health, 5 pct would be the likely 10-year yield. Such a future might be described by inflation returning to 2 pct and a more normal growth cycle, which would vary around the trend growth rate somewhere between 2.5-3 pct. Adding a small risk premium, such an environment would be broadly consistent with US bond yields at 5 pct.

I now find myself thinking that if these thoughts go through my mind, then the same is likely to be true for many others when they start to believe that the US economy might be returning to normality. It is conceivable that this could happen in 2011, especially if the US and other companies around the world starting spending their large cash holdings and banks return to lending.


Surprise surprise, none of us know that either. But let me take a stab.

For all the bears that think it could only occur because of the irresponsibility of US fiscal policy and rising inflation, and others that probably believe a rise to 5 pct bond yields would lead to another recession, the key way of thinking about the issue is in terms of US financial conditions.

In the GS Economics Department’s US Financial Conditions Index (FCI), a close proxy for10-year bond corporate bond yields have a weight of 55 bps. It is probably the case that a 168 bps rise in 10-year government bond yields would have a significant impact on the FCI, although it is possible that corporate–government bond spreads would narrow. The direct impact, if the FCI used only government bond yields, would be just over 90 bps.

What would happen to the overall US FCI would then depend on the other 45 pct, made up primarily of short-term interest rates, the trade-weighted Dollar, and an index related to the stock market.

If the bears were right, and such a rise is really because of the state of US fiscal affairs, then the Dollar might fall and corporate bond spreads tighten, which would offset some of the 90 plus bps tightening. A decline in the equity market would tighten conditions further. Such a move of the FCI would itself, in turn, dampen the longevity of any sharp US recovery.

If the optimists were right, and if any rise in US bond yields continued because of a return to normality, then in fact, the Dollar might rise, corporate bond spreads certainly tighten, and the stock market rally, possibly significantly. In fact, checking my simple stats with Jan Hatzius this weekend, the US stock market would “only” need to rise by around 19 pct in order for the 168 bps rise in government bond yields to be entirely neutralized.

Are 5 pct US 10-year yields and an S+P of 1475 possible in 2011? We shall see. In my opinion, a 19 pct rise in the US stock market seems quite likely. As for 5 pct bond yields, I think they are much less likely, but not impossible. If they did occur, it certainly wouldn’t have to be for negative reasons.


This is a topic for a separate piece. But, in my judgment, among reasons why it wouldn’t entirely be a bad thing are the two great debates surrounding the future of the monetary system, and separately the true strength of conviction about US$ based capital moving into so-called “emerging markets.” A few things seem clear to me:

1. The Dollar would strengthen somewhat, especially against the Yen. All comparisons with Japan’s lost two decades would rightly diminish.

2. The problems of European Monetary Union would appear relatively starker, although a stronger US economy combined with the strength of the BRIC countries would be good for European growth.

3. World GDP growth might exceed 5 pct for a while.

4. Money would leave emerging markets by those that treat them as old fashioned emerging markets, leaving the table more open for those that rightly regard a lot of those countries, especially the bigger ones, as “Growth Markets.”

5. More money might flow from debt to equity in the EM/Growth World, rather than back to the more developed markets.

Much to look forward to, not the least of which is the coming holidays and all that exciting football in the next fortnight!
Jim O’Neill

Chairman, Goldman Sachs Asset Management

in other words:


Comment viewing options

Select your preferred way to display the comments and click "Save settings" to activate your changes.
asdasmos's picture

Burn, baby, burn.

Eternal Student's picture

He's certainly burning something, and I caught a whiff of it. Woof. That's some strong hopium. Now if you'll excuse me, I need to step outside and let my head clear.

Herd Redirection Committee's picture

I liked his suggestion that somehow Quantitative Easing will come to an end because it is politically unpopular!

This is basically Goldman Sachs trying to convince us "No no, its not a small Oligarchy that is running things, its the free market that decided interest rates will go up, and if the people disagree with the Fed's policies like QE2, the Fed will listen!"

Yeah f*cking right!  The illusion of democracy is all that remains, so good luck GS, on maintaining it!

Check out our latest PsychoNews story: "The Calm Before the Storm"

"In other news, the Bank of Canada announced its intentions to devalue the Canadian dollar.  It is America's fault, naturally.  Canada did not want to devalue, but for the 'good of all Canadians' it will.  This is exactly why PsychoNews was founded, because Central Bankers are constantly making decisions which they purport to be in the best interests of everyone involved, while actually only being in the best interests of a small financial elite."

tgatliff's picture

I loved his "no one will ever know"... It certainly cannot be that foreign capital is rushing away from the worlds reserve currency.. No, I mean no one would know if that happened.  Nope.. Nothing to see here.. Move along.. Move along...


In short, were screwed and he knows it...

deez nutz's picture

if only most American knew how much benefit Canadian businesses received from a weaker dollar.  Can you imagine having a 20% price advantage over your competition? 

Beggar they neighbor.

IQ 145's picture

 World GDP growth might exceed 5%? WTF.? What a wingnut.

Drag Racer's picture


ha ha, you've been listening to our presydend

RobotTrader's picture

Did bonds finally bottom out Thursday?

liberal sodomy's picture

The bottom corresponds to the tic with bill gross implying that he will be selling bonds and buying equities.

edwardscpa's picture

Since when did Gross become a top-ticker?

Lionhead's picture

No, you're confusing true supply/demand sentiment with FED POMO operations that distort any true reality in the UST market. You know better than that.... Any countertrend rally enables the shorts to reload at higher levels.

taraxias's picture

No, sadly, he *doesn't* know better than that.........

Eternal Student's picture

Is it me, or does the POMO game not seem to be doing much? Real Estate is coming apart, stocks are so-so, and JPM has been getting hammered in their efforts to beat down Silver.

It seems like they are in the process of losing control.

penisouraus erecti's picture

More videos like one you posted above.........

gerd's picture

wait, now you're a top/bottom picker and not a trend follower?!

tgatliff's picture

Oh no... FED Super Heros Activate!!  Go super Timmy... Threaten those foreigners with your MAD argument super powers!!  Go super Benny... Hose down with cash anyone who even mentions the idea of abandoning the great cartel...

AR's picture

ROBO  /  As always, we hope you are well.  The other day we posted the following on Bonds (see below).  Bonds will remain a little sloppy and volatile for the next 2-3 weeks, but can retrace some of the 8-10 day recent sell-off (see levels suggested below). Nimble traders can probably trade BOTH sides of this market during this time pulling out 16-32 ticks. In this period, we would not marry oneself to any particular side however (rather trade the ranges the market gives you).  Good luck our friend, as we always find your posts worthwhile and entertaining.---------------------

by AR
Wed, 12/15/2010 - 15:13
#809157   / 
In BONDS  /  Yesterday (On Tuesday 12/14) we suggested the following:

by AR  /  on Tue, 12/14/2010 - 17:03  / #806134 

We might be a little early, but, we suspect this recent down leg in treasuries is close to a short-term bottom. 30's tested our 119.07 support target area today. Thus, it would not be unusual to see 30's bounce and retest the 124.00/125.00 area testing the staying power of the shorts. We've had a quick 8-9 handle move down in the last 10 days. Therefore, the risk here is overstaying one's shorts. This market will give everyone another sell signal from higher levels. It's prudent to peel back some exposure down here if one hasn't already. Good luck everyone.  -------------------------------------

Today (On Wednesday 12/15), again, we just retested these levels (actually 118.21).  There is a lot of "overhead pressure" on this complex right now (which will abate in the next 2-3 weeks). Much of it comes from the fact that few PM's are in the black in this sector after this recent 10 day meltdown of 8-10 handles. If long positions are initiated, do not be afraid to quickly take profits and trade them aggressively until you see some better stability in price levels. 16-32 ticks per day is not unreasonable trading them with this type vol and in this environment.  Short-term risk is down to 117.27 area if these levels are breached in 30's. We are hearing margin departments are being very aggressive this week as the direction (lower) wasn't a surprise, however, the size of the move in this short time period was. Some too may want to look at the calls for the 123 to 125 strike (February or March expiry). Good luck everyone.  --------------------------------------------


chopper read's picture

friday.  temporarily as CME Group raised margin requirements while Fed bought them back up.  desperate one-two punch.  when it crosses through the weekly 21-period moving average and touches the far side bollinger band, then sell the bounce.  if the T-bond goes back to 2010 highs then I'll eat my hat. 

litoralkey's picture

( 19 pct rise in the US stock market ) equals some ( X pct drop in USD )

The US Dollar would have to devalue for the S&P (with 47% of revenues from foreign operations ) to hit 19% gains next year, or the devaluation will be a tightly wound spring that will devalue rapidly... The Bernank said there will be no rapid deval scenario allowed, so a continued USD devaluation in 2011 between 5 % to 10 % is baked into this report.

Sounds more bullish on commodities than equities.


IMHO... any thoughts on this?

hedgeless_horseman's picture

 So at age 19, I found myself sitting on ol' Trigger outside a butcher shop in Belgium, and no money.  If it weren't for my horse, I wouldn't have spent that year in college.

LeBalance's picture

What would happen to real estate with a 10-Year rate of 5%!


Salinger's picture

have you noticed that most pundits while acknowledging that real estate has much more room to drop are also discounting the impact of that deterioration on the wider economy

the thinking goes something like -


things have fallen so far, what's another 10 or 20%

employment in the home building sector has already been hit no more downside

banks have already taken the right downs


sort of like the list of lies from an article a few days ago


Cdad's picture


Exactly!  It is contained.  Who cares if another million people bail on their houses?  To hell with plumbers and electricians...we don't need them anymore.  And we don't need any more copper and that won't affect things over seas.  As well, Average Joe does not need a taste of Wealth Effect. 

None of this will have negative impact on UnicornDew production or PixieDust factories. And nothing matters any more because The Bernank will just print another trillion dollars and jam it into the Blight of America bank. 

So I am with you, brother...sipping some UnicornDew right now, in fact.


Rainman's picture

Yup, I guess he figures a 5% 10y will bottlerocket sales in the housing market and really clear out the massive shadow inventory. Okie-dokey.

SteveNYC's picture

Don't forget the "healthy (Bernanke) gains in real income that we are all experiencing, hand over fist, right now!! Yeah baby!!

lamont cranston's picture

Good God, where did this bozo matriculate - Whatsommatta U.? Sheetrock State Teachers College with grad work at Bob Jones?

So, let me get this right...if the 10 goes to 8 or 10% the market will zoom another 15-25%???

zaphod's picture

Harvard b-school, I think thats were they teach this stuff.

The K-12 schools do a good job of instilling this line of thought also.

liberal sodomy's picture

The ponzi scheme run by goldman at the NYSE can "go up" 19% if the bernank devalues the ponzi dollar by 40%.

That is all.


Spalding_Smailes's picture

Stocks like the ( large money center banks/usa ect ... )C,BAC,JPM,WF---also LVS,MGM .... will go up with the dollar next year.

Book it.

liberal sodomy's picture

Too bad about the avalanche of option arms resets coming due q1 that aren't going to like these higher rates one bit. But that is the point now, isn't it?  Debt as weapon.  The jews' stock in trade.

Problem Is's picture

Hmmm... Modus Operandi of a backdoor bailout program for TBTF banks by increasing revenue/ cash flow by skewering option arm resets?

How deviously clever of you Bernank....

Spalding_Smailes's picture

The big banks will benefit from continued improvement in credit and lower provisioning and charge-offs will be a big boost to earnings. The shadow issues are under the rug/off balance sheet/priced in, gone.

C & BoA will go up 50% in the next 12 months.


Price / eps = deal of a life time with the banks. Buy low, ( blood in the water - sure news is bad ) you will look back in 12-15 months and wish you did.

Id fight Gandhi's picture

Good points. Seems they have no interest in saving this country, just suck it dry and move on.

CrashisOptimistic's picture

Pretty much all such analyses are data mining.

Rates on the 10 year will rise to 5% and reflect strong economy?  But won't a rise of 10 yr instruments to 5% immediately raise mortgage rates and smash even more house buying, lowering house prices and lead more people to choose strategic default?  And doesn't that add more worthless mortgages to bank inventory?

He had 4 different reasons for a rise to 5%, chose one that was glowing, and ensured that one carefully did not address impact on housing.  This is not good analysis.

My guess is the bonds will not surge their rates any further because growth will not manifest itself.  American net worth remains predominantly in their houses and those have rolled south once more in the latest Shiller data.

The one item of strength to think about is how corporate CFOs have aggressively run up debt for their companies at these hyper low rates.  That's the source of their cash.  Where will it go?  Share buybacks, acquisitions and bonuses.  Equities will be supported as unemployment raises post acquistion, as redundant personnel are booted.




Atomizer's picture

Much bigger event to look at.

Dispatch: Presidential Elections in Belarus From: STRATFORvideo | December 15, 2010  |

Regardless of whether incumbent and likely winner Aleksandr Lukashenko emerges victorious from Belarus' upcoming presidential election, Analyst Eugene Chausovsky says Belarus will remain under Moscow's thumb.

CrashisOptimistic's picture

First of all your link doesn't work.

Second of all, why is this important if nothing is going to change? 

Atomizer's picture

Abracadabra... waves black wand & throws pixies dust into air.

You need to follow politics to make money. Your in the mist of a global labor war. Governments don't pay for new infrastructure, peasants do.

Problem Is's picture

What a crack head...

" GDP growth could be above 3 pct, and it would not surprise me if some start forecasting close to 4 pct soon."

Spalding_Smailes's picture

Its true.

By the middle of next year you will be kicking yourself for not buying in December. LVSands will be $70-80, US Steel $80 plus..

penisouraus erecti's picture

Wish in one hand, shit in the other. See which one gets filled first. 

And we see this by the ENORMOUS jump in hiring going on out there.


10044's picture


Julian Assange Calls ABC News Reporter 'Tabloid Schmuck' And Walks Off When Asked About Rape Charges
Salinger's picture

FYI businessinsider could also be considered 'Tabloid Schmuck'

One Ton Lady's picture

Curious use of terms for a Aussie. 

zaphod's picture

Now that's how you treat the press. Mock away Julian, they'll still follow you around and love you.