Repeating what has become an annual tradition, this morning Goldman - which started off the year expecting higher 10Y yields around the globe on assumptions of rising economic growth and stronger inflation - cut its bond yield forecasts for all the G-10 countries based on changes in the outlook for monetary policy and inflation in several regions and less recovery in term premium in the U.S.
"We have generally revised our path for yields lower on two grounds: First, we tweak our forecasts to reflect changes to local policy expectations and inflation trajectories. Second, we now expect a smaller amount of term premium repricing in the US and, by extension, smaller spillover effects into other non-US yields" Goldman's Praveen Korapaty wrote however adding that "the direction of travel is still higher yields across the G10."
Goldman's changes to the path for US, Canada, and Norway bond yields "are modest for 2018" while elsewhere the bank "revised down its 10-year yield forecasts more sharply." The reason is that In both the Euro area and Japan, we account for a later start to normalization following ECB and BoJ forward guidance this summer and a weaker inflation path. In the UK, we lowered the path for Gilts by 50-60bp in 2018 as we mark-to-market political risks associated with Brexit.
Downward adjustments to end-2018 forecasts for U.S., Canada and Norway yields were "modest"; expectations were lowered “more sharply” for euro-area and Japan yields "based on later start of policy normalization by the ECB and the BOJ’s forward guidance from July, as well as a weaker inflation path."
Broken down by region, for the US, Goldman cut its end-2018 forecast for the 10-year Treasury yield to 3.10% from 3.25% and lowered the cycle peak level by 20bp to 3.4%. The revision to U.S. forecasts reflect lower expectations for term premium recovery, now forecast to increase by 30bp-40bp. Goldman's clarifies that its Fed call is unchanged, with another six hikes expected, one per quarter until the fed funds rate reaches a range of 3.25% to 3.5%.
Elsewhere, Goldman predicts that 10-year German, U.K. and JGB yields will end 2018 at 0.5%, 1.45% and 0.12% respectively,
Goldman's Euro-area growth remains above trend but slow relative to 2017, and underlying core inflation should remain stuck at 1%, leaving ECB unlikely to raise deposit rates before next summer, Goldman predicts.
The ECB appears to share a similar outlook, suggesting that it is unlikely to raise the deposit rate before next summer. As a result, pricing of deposit rate hikes in EONIA forwards has dropped a fair bit (Exhibit 2), dragging 10y core yields lower in the process.
There’s also less upward momentum in term premium due in part to “an expected overhang from the Italian budget standoff.”
Goldman also writes that that markets are underpricing what we think will be the likely path of policy rates in the Euro area—for instance, our economists expect a 20bp hike to the deposit rate by 4Q2019 (likely in October), and about 70bp by YE2020, but EONIA forwards are pricing only a ~40bp increase. Over the course of next year and 2020, as the ECB.
For the UK, Goldman concedes that "Projecting UK yields is a trickier exercise, given the uncertainty around a Brexit agreement,” Goldman says; their baseline scenario is that PM May gets a withdrawal treaty through parliament very late in 2018 or in 1Q 2019. Remote chance of no deal nonetheless requires "a risk premium."
In Japan, “recent forward guidance from the BoJ effectively rules out further ‘tweaks’ to monetary policy, at least until the effects of a consumption tax hike begin to dwindle."
And here is Goldman's detail justification of the latest downward yield revision:
Since we last published these forecasts, several facts have changed that necessitated updates to our projections, including ECB and BoJ forward guidance, political developments in Italy, and more modest assumptions for term premium repricing.
As can be seen in Exhibit 1, our new projections are lower across the board for this year, although the direction of travel is still towards higher yields.
We now forecast that US 10y yields will be around 3.10% (vs. 3.25% previously) by year-end 2018.
The changes we have made to European and Japanese forecasts are more substantial—with 10y German, UK, and Japanese rates ending the year at 0.5%, 1.45% and 0.12% respectively. These revised forecasts are still 10-20bp above forwards for end-2018, except in the case of Japan, where our projection is modestly below the forward.
Finally, Goldman's long term forecast through year-end 2021, are only slightly lower in the case of the US, Germany, Sweden, and Norway (by 15-25bp), whereas revisions for Japan, Canada, Australia and New Zealand are more substantial (45-60bp).