Goldman Slashes Treasury Yield Forecasts

Tyler Durden's picture

If it appears like it was only yesterday that Goldman was advising clients to short the 10 Year Treasury, it is because it was... give or take a few months: From January: "Since the end of last August, we have argued that 10-yr US Treasury yields would not be able to sustain levels much below 2% in this cycle. Yields have traded in a tight range around an average 2% since September, including so far into 2012. We are now of the view that a break to the upside, to 2.25-2.50%, is likely and recommend going tactically short. Using Mar-12 futures contracts, which closed on Friday at 130-08, we would aim for a target of 126-00 and stops on a close above 132-00." We added the following: "As a reminder, don't do what Goldman says, do what it does, especially when one looks the firm's Top 6 trades for 2012, of which 5 are losing money, and 2 have been stopped out less than a month into the year." Sure enough, as we tabulated last night, those who had listened to this call, and also gone long stocks as Goldman urged on March 21, have lost nearly 30% in about 2 months. Those who listened to us and did the opposite, well, didn't. Which is why the just released note from the very same Garzarelli who 4 months ago was so gung ho on shorting bonds, just cut his bond yield forecast for the entire world, US Treasurys included: "We now see 10-year US Treasuries ending this year at 2.00% (from 2.50% previously, and 30bp above current forwards), rising to 2.50% (previously 3.25%, and 60bp above the forwards) by December 2013. The corresponding numbers for German Bunds are 1.75% and 2.25%." In other words, it is now that Doug Kass should have made his short bonds call: not when he did it, a month ago and got his face bathsalted right off. For those asking - yes: Goldman is now selling bonds to clients.

Here is the summary:

How does Goldman get there:

Reflecting an intensification of sovereign pressures in the Euro area, we are lowering our forecasts for the major government bond markets. We now see 10-year US Treasuries ending this year at 2.00% (from 2.50% previously, and 30bp above current forwards), rising to 2.50% (previously 3.25%, and 60bp above the forwards) by December 2013. The corresponding numbers for German Bunds are 1.75% and 2.25%.


A Recrudescence of EMU Risks


The month of May has seen a strong rally in interest rate markets in the developed economies, accompanied by a flattening in term structures. There have been two proximate drivers of the price action. The first is a modest decline in leading indicators of global  industrial activity, as captured by our GLI. This has been reflected in both cyclical stocks and rates.


The second, and more dominant, force has been a resurgence of market pressures in the Euro area sovereign space, tied to developments in Spain and Greece. In the former, investors concerns relate to the recapitalisation of commercial banks, and the impact this could have on borrowing requirements. In the latter, a political stalemate has raised the spectre of a break away from the common currency union, reinforcing ongoing portfolio allocations within EMU towards bonds of the highest credit standing.


Germany has been leading other major rate markets: 30- year Bund yields have fallen more than 60bp since the start of May to below 2% (corresponding to a total return over this period of 15%). To put this in perspective, they are on par with 30-year yields in Japan—where domestic inflation is running 200bp lower. Even at these depressed yield levels, the ‘call skew’ on July Bund options for delivery on June 22, that is, after the second Greek parliamentary elections) has continued to increase.


Formal statistical tests confirm that, in a departure from historical norms, since March 2012 the causation has run from German yields to those in the US.


The flipside of such extreme shifts in German yields has been a meaningful increase in long-term spreads of Italy and, in particular, Spain relative to the core countries of EMU. Demand for intermediate maturity bonds from these two issuers continues to be low, and almost entirely domestic—as we had long expected. Intra-EMU government rate differentials now embody an element of  currency risk. They are at levels far above what would be justified by relative economic fundamentals should concerns over the viability of EMU abate.


1. An Increasingly Bimodal World


When benchmarked against our central macroeconomic expectations, intermediate maturity yields in the main economies have reached levels that, on past norms, would lead us to recommend short positions.


Our Bond Sudoku framework, which provides us with an indication of how expected global macro factors should map into intermediate maturity government bond yields, suggests that German Bunds, US Treasuries and UK Gilts are now trading around 100bp too expensive relative to ‘fair value’, equivalent to a departure from the fitted value of well beyond one standard deviation.


We comment on the merits and limitations of Sudoku below, but the same conclusion is reached if we use alternative approaches tobond valuation.


The main issue we face at this juncture is that the distribution of possible macro scenarios, and hence that of expected government bond returns, is becoming progressively bimodal. Ahead of us, we think, lies a central macroeconomic scenario with quantifiable risks around it. Alongside this outcome, however, there is a much less probable but also much more harmful alternative, where depressed economic activity and uncertain institutional shifts in the Euro area interact. In this context, summary statistics such as mean and standard deviations could be deceptive.


2. Our Baseline Case: Gradual Progress Towards


Deeper Integration in the Euro area As we set out in a recent note (see The Euro area: 3 Greek Scenarios and Market Implications, May 28, 2012), our baseline case for Greece envisages: (i) a (painful) modification of the ‘troika’ program; (ii) continued ECB funding for local banks under Emergency Liquidity Assistance (ELA); and (iii) the rest of Euro area slowly and discontinuously progressing  towards deeper integration in the areas of financial and banking regulation and fiscal policy.

Such integration encompasses all the main ‘desiderata’ we have written about in previous research. These include the EFSF helping Spain out under a Memorandum of Understanding specific to bank recapitalisations (i.e., not a full macroeconomic adjustment program); a common Euro area wide bank resolution authority regime and, eventually, a merger of deposit insurance schemes; a political agreement to reach a mutualisation of legacy debt subject to conditionality and collateral. These are admittedly ‘end game’ solutions, which can be implemented over the space of several quarters, rather than weeks. But markets would be reassured by theanchoring of medium-term expectations around a policy objective shared by all member countries.


In this world, the very large insurance premium priced into German Bunds and US Treasuries since last summer should gradually dissipate as Europe slowly becomes more integrated and resilient to events in Greece, allowing bond yields to realign themselves to their macro underpinnings.


Within this central case we would expect peripheral spread curves to remain relatively steep, underpinned by the ECB’s ‘term liquidity on demand’ policy. Both the level and slope of intra-EMU spreads would interact primarily with shifts in the growth outlook.  An exercise of mapping spreads to fundamentals predicated on the baseline scenario would see 10-year differentials with Germany  head towards 250-300bp for Italy (currently 465bp) and 300-350bp for Spain (currently 530bp) on a 6- to 12-month horizon.


It is conceivable that more positive developments could take place. We have, for example, discussed the merits of the European Debt Redemption Fund, which we outline again in the Focus section. Any hint of the Euro area moving in these directions would  result in a sharper rise in German yields towards their macro equilibrium, and a compression of German swap spreads to 20bp-25bp from 50bp currently), with 10-year Italian bonds trading around 150bp-200bp over mid-swaps.


3. And a Darker Mode


But there is also an alternative scenario, in which a withdrawal or expulsion of Greece from the single currency could result in a hit to the Euro area’s aggregate GDP of around 2%, assuming robust policy responses. Failing those, the risk of a broader collapse of EMU could be material, and the contraction in economic activity approach double digits. It is this sort of ‘rare event’ risk that has led to a decline in traded volumes over the past months, a build-up of cash balances and a ‘flight-tosafety’.


Arguably, high credit quality government bonds incorporate a greater chance of bad outcomes occurring than other assets. The 3-month rate in 10-years’ time in Germany is now priced at 2.0%, at the ECB’s area-wide inflation rate target. The corresponding number in the US is 2.3%, approaching levels seen after the collapse of Lehman Brothers, and in the UK is 3.0%.


Nevertheless, in a world where the demand for creditriskless fixed income assets outstrips supply (the latest IMF Financial Stability Report provides a comprehensive overview), high rated government securities could be in greater favour than we have so far assumed.

Which all leads to...

Our Forecast Changes Reflect a More Gradual Adjustment


Drawing on these observations, we are lowering our major markets’ interest rate forecasts to reflect a more gradual adjustment of intermediate nominal yields towards values consistent with their macro underpinnings.


  • We now see nominal 10-year US Treasuries ending this year at 2.00% (from 2.50% previously) and then gradually rising to 2.50% by December 2013 (previously 3.25%), approaching our Sudoku measure of ‘fair value’ from below. At the time of writing, with spot yields at 1.6%, our end-2012 forecasts are 30p above the forwards, and those for end-2013 are 60bp above the forwards.
  • The corresponding numbers for German 10-year Bund yields are 1.75% in December 2012 (previously 2.25%), 40bp above the forwards; and 2.25% (previously 3.00%) in December 2013, 70bp above the forwards.
  • We forecast 10-year UK Gilts at 2.00% in December 2012 (previously 2.75%), 25bp above the forwards; and 2.75% (previously  3.50%) in December 2013, 75bp above the forwards.
  • Lastly, we see JGBs at 1.00% in December 2012 (previously 1.25%), broadly in line with the forwards, and 1.30% in December 2013 (previously 1.70%), or 20bp above the forwards.
  • Along similar lines, we are also lowering the forecast for 10-year rates on the bonds of Canada, Australia, Switzerland and Sweden, as summarised in the Table below.
  • We see two main reasons why bond yields should increase over the forecast horizon:
  • First and foremost, we expect a relaxation of strains in the Euro area, consistent with the baseline case sketched out above. As  already mentioned, however, it may take more time for flight-to-safety flows to reverse given the damage to investors’ confidence experienced over the past year.
  • Second, we are forecasting a sequential improvement in nominal GDP growth in the advanced economies. Our present forecasts envisage a quarterly annualised expansion from 2.75%-3.00% in the first half of this year to 4.75%-5.00% between 2012Q4 and end-2013. Although we do not expect any of the major central banks to adjust policy rates upwards over this horizon, markets may start discounting changes over 2014-16.

And so on.

Bottom line: take whatever Goldman say, and flip it.

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mayhem_korner's picture



The silver bears post just got funnier.  This is the definition of blatant.

The Monkey's picture

Gary Shilling and Lacy Hunt smoke the consensus, again.

Comay Mierda's picture

Goldman just raided TLT to prove a point.  What phucking criminals these guys are. Anyone who shorts bonds now on the advice of Goldman deserves to lose money

The Monkey's picture

Goldman did jack shit.  The treasury market is forecasting a global recession with a chance of financial crisis.

boogerbently's picture

EUro down = USDollar up = gold ????

Safe haven, commodity, down as dollar up ???

Michael's picture


Complete and Total Worldwide Economic Collapse 2012

Beevreetr's picture

The bath salt jokes never get old...

Bastiat's picture

Recrudescence, bitches.

vast-dom's picture


bdc63's picture

TBT - LOL.  if you had bought it in June '11 you would currently be down 50%.  June of '09? -- you would be down 70%.

ShorTed's picture

It's impossible to BTFD (Buy This Fucking Dog?) when it keeps making new lows. The dip looks like the Mariana's trench....down, down, down.

bdc63's picture

I'm still waiting for CNBC to give Goldman some airtime to explain why their predictions this year have been so ridiculously bad ... I suspect I'll be waiting for awhile

azzhatter's picture

Bring out that Abby Joe Cohen guy

junkyardjack's picture

Damn Goldman goes bullish and TLT flash crashes....

5880's picture

Is that Elaine Gazarelli?

geewhiz190's picture

sold 1/2 position TLT, put on 1/2 positon yen short with close stop about 2 % above current market. went long some japanese ADRs

The Monkey's picture

I've sold long treasuries after holding them for a year.  But, I sure as hell wouldn't short them at this point.

Dr. Engali's picture

Well my original thoughts were that we would see sub 1% yeild on the 10 year since we are all I have to rethink that position.

NotApplicable's picture

They're still calling for a 50bp increase from current levels. So... I read that as a decrease down to the sub 1% level.

Can a brother get a ZIRP?

Mark123's picture

Is there an inverse etf for Goldman client recommendations?  Preferably 3X....

flacon's picture

Gold = 1X

Silver = 3X

The Monkey's picture

No - Goldman is expecting higher gold prices.

brooklynlou's picture

If people are paying the SNB to store their money during the Euro death spiral rodea, odds are that in the short term, our bonds will go lower as well as capital flight to safer havens continues. Its better to keep 99.99% of your money than lose 50%

NotApplicable's picture

Especially if it's OPM and your only concern is nominal.

Seasmoke's picture

dont bathsalt me bro !

pissing_excellence's picture

First cheese heroin then bath salts, whats next.

markar's picture

So Goldman is predicting the demise of JPM with this forcast? For certain, with JPM's $trillions in IR swaps, a 2+% rate on the 10 year will drive a stake through their heart.

Mister Ponzi's picture

Goldman has slashed its year-end bond yield forecasts, but the yield forecasts are still much higher than today's levels. So, I don't see how this note can be interpreted as an invitation to buy bonds. I mean, Bunds yield 1.2% currently. If they yield 1.75% at the end of the year, you make a total return of around -3% if you buy now.

Ookspay's picture

Thanks Bro...

I'll have an Absolut and Tonic, 2 limes!

Fox-Scully's picture

The question is--When Goldman is on the street corner selling pencils, would you buy one?

NotApplicable's picture

Only if I'm close enough to stick it in their eye.

_ConanTheLibertarian_'s picture

Let's see... we are entering phase 2 of this depression so stocks will go down and bonds will go up. 

Since you should do the opposite of what a bank recommends this all makes perfect sense and it confirms we're exiting the eye of the storm.

Downtoolong's picture

Sell side advice. AKA, how to lie about how much you're lying about the lie you told yesterday.

EclecticParrot's picture

I understand Goldman research reports are increaasingly becoming mainstays in dental office waiting areas throughout North America, as they have the quintessential qualities that make for a fine pre-drilling read:  a light, frothy, moderately absorbing blend of unconfirmable fact, light fiction and breezy fantasy, presented in a sensible, well-chosen font.

slewie the pi-rat's picture

as theHazmat been away?

or did he just not want any more friendly zH attention?

party 000,000,000,000-on, BiCheZ!

slewie the pi-rat's picture

well, this is disclosure materiel and also slewieNewZ-worthy:

tyler has just plopped down a benjie in the zH parimuteuel "whichSquid will gotoMadrid?"

on janHazmat!

is this a head-fake or the realJake?

who else could be more acceptable to theTimmah, theImf moneyHoney, and the poor peonsDelponz? 

newZ before it happens! 

here, where fearBeerTMis near

lewy14's picture

and got his face bathsalted right off

This is the Tyler we know and love.


cramer and doug cass must subscribe to the goldman top pick newsletter and get all their picks from goldman---fucking rat bastard cocksucking rodents.