Interview, Podcast
How much higher can bond yields go?
- Interest rates are projected to remain sticky due to resilient economic data, with the Federal Reserve nearing the peak of its hiking cycle, followed by a prolonged period at terminal levels; Goldman Sachs' baseline forecast estimates this terminal rate between 5.25% and 5.50%, though upside risks exist from sticky inflation, while other central banks face different trajectories, including the ECB with a baseline terminal rate of 3.75% (with upside to 4%) and a less aggressive Bank of England.
- The 10-year Treasury yield is expected to peak at 4.25% in the third quarter of the current year, reach 4.2% by year-end, and subsequently decline to 4% next year as the long-run equilibrium, with a potential low of 2.5% possible if the economic environment moderates; conversely, higher rates could trigger upside risks to long-term yields if the Fed exceeds the 5.5% baseline.
- Macroeconomic forecasts anticipate a moderation in late spring and summer leading to a steepening yield curve, followed by slower growth in 2024 and 2025 driven by demographic trends and reduced fiscal stimulus, yet a recession or deep recession is not expected.
- Monetary policy shifts are anticipated to include Federal Reserve rate cuts in 2024 and 2025 as the economy slows, while the Bank of Japan is expected to maintain easy monetary policy but may exit Yield Curve Control (YCC) at the 10-year point, potentially shifting it to the 5-year point, a move that could cause a 15 to 20 basis point short-term market impact unless driven by inflation which risks sharper yen strengthening.
- Fixed income assets and active lending strategies are identified as favorable due to a massive influx of pent-up demand for yield from cash holders, with the firm reducing cash levels significantly; European credit and equity markets are viewed as more attractive than US markets on valuation and technical grounds, particularly for dollar investors.
- Risk management tools are expected to improve due to lower currency volatility and reasonable equity volatility, allowing for the use of options and duration strategies, while the US labor market and growth data suggest a potential for the 10-year UK gilt yield to reach 4% with inflation risk premiums driving real rates higher.