Goldman Still a Bond Bear After Treasury Yields Slump to Records

Why Treasury Bond Yields Are at Record Lows
  • ‘U.K. is not a global economic bellwether’: Goldman’s Khanna
  • Goldman sees at least one Fed rate increase likely this year

Goldman Sachs Group Inc. says Treasury investors have overreacted to the U.K.’s shock vote to leave the European Union by sending yields to record lows.

The bank says it would “lean against this recent rally” in bonds on the assumption the local impact of a Brexit will have “a limited or negligible spillover to rest of the world,” and won’t prevent the Federal Reserve from raising interest rates this year. Yields on 30-year Treasuries dropped to an unprecedented level on Tuesday, after 10-year yields reached a record low on July 1 amid a rally in sovereign debt worldwide as the U.K. referendum result clouded the outlook for global growth.

“The U.K. is not a global economic bellwether, and hence any economic activity slowdown should have limited impact,” Rohan Khanna, a London-based interest-rates strategist at Goldman, wrote in an e-mailed research note. With regards to U.S. monetary policy, “we assign a cumulative two-thirds probability of at least one hike by year-end,” according to the note.

Fed fund futures signal 12 percent odds of higher rates this year, and still less than even odds at the end of 2017.

Record Lows

The 10-year Treasury note yield dipped to an unprecedented 1.3784 percent on July 1, before 30-year bond yields slid to a record 2.1681 percent on Tuesday. The 10-year yield was at 1.40 percent as of 8:10 a.m. in London. Treasuries didn’t trade Monday because of the Fourth of July holiday in the U.S.

Uncertainty over the When and How of a Brexit adds to concern about the robustness of the U.S. recovery, after employers added just 38,000 jobs in May, the least since 2010. Economists estimate a 175,000 increase in payrolls for June, before the data is released Friday. The average over the past five years is a rise in excess of 200,000 positions per month.

Goldman has had a difficult time predicting markets in 2016, after it was forced to drop five of its six recommended top trades just six weeks into the year, including a wager on a rise in 10-year break-evens.

The bank has stuck to its view that yields are poised to rise, and that investors are underestimating the potential for higher U.S. rates and inflation. The bank’s year-end estimate for the 10-year yield began the year at 3 percent -- a call it carried over from 2015 after it failed to materialize -- and has since been trimmed to 2 percent. The consensus forecast is 1.87 percent.

Brexit “is unlikely to stop the hiking cycle given the cyclical position of the U.S. economy,” Khanna wrote in the most-recent note. “With above trend growth, the U.S. is moving swiftly towards full-employment.”

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