Goldman Expects 3% Treasury Yields Next Year, Echoing 2015 Call

  • Bank reiterates 10-year forecast that proved wrong this year
  • Median survey estimate sees 2.8% yield by the end of 2016

Goldman Sachs Group Inc. says the higher path of Federal Reserve interest rates in 2016 will have too strong an impact on the $13.1 trillion Treasury market for yields to remain as low as they are -- and for the bank to be wrong two years in a row.

Goldman, one of 22 primary dealers that trade directly with the Federal Reserve, is forecasting 10-year Treasury yields will climb to 3 percent by year-end 2016 from 2.29 percent Wednesday, reiterating a call it made at the beginning of 2015 that didn’t materialize. The yield, the benchmark for rates on everything from mortgages to car loans, hasn’t touched 3 percent since January 2014, and derivatives prices indicate it won’t get to 3 percent this decade.

"U.S. yields are below where we thought they would be a year ago," as this year’s drop in oil prices "proved to be a larger and more persistent drag" on inflation, Francesco Garzarelli, Goldman’s co-head of macro and markets research in London, wrote in a report. Higher policy rates in the U.S., a pickup in inflation and "above-trend" economic growth will propel yields higher in 2016, Garzarelli said.

Goldman recommends investors stay short 10-year Treasuries and buy 10-year German bunds. A short is a bet that the price of a security will drop. The bank also recommends investors buy 10-year inflation-protected securities.

Forecasters have been wrong-footed in recent years as Treasury yields remained low, defying expectations that they would rise as the Fed moved closer to lifting rates for the first time since 2006. Yields were capped in 2015, forcing forecasters to lower estimates, as global central banks added stimulus while China’s slowing economy and plunging commodity prices stymied inflation.

Fair Value

The 10-year note yield fell one basis point, or 0.01 percentage point, to 2.29 percent as of 5 p.m. in New York. The price of the 2.25 percent note due November 2025 rose 3/32, or 94 cents per $1,000 face amount, to 99 19/32.

Forecasters also overestimated the number of Fed increases, as the central bank’s Dec. 16 rate boost was the only one this year. While policy makers have indicated they intend to raise rates as many as four times in 2016, the bond market is anticipating two increases. The 10-year yield will end next year at 2.8 percent, according to a Bloomberg News survey.

The downward pressure on oil will reverse next year and the Fed will raise rates four times, starting in March, by a cumulative 100 basis points to 1.3 percent, according to Garzarelli, who said the 10-year note’s current fair value is 2.7 percent. Goldman sees risks to its 2016 forecasts including a further decline in oil and commodity prices, which would lead to lower bond yields.

Note Auction

The U.S. sold $29 billion in seven-year notes Wednesday in the last coupon auction of the year. The bid-to-cover ratio, a gauge of demand, was 2.34, the lowest since March. Demand fell to the lowest since 2009 for a sale of five-year debt on Tuesday and a sale of two-year securities on Dec. 28.

The seven-year security yielded 2.161 percent, the highest at a sale of the maturity since June and up from 2.01 percent at the previous sale on Nov. 25. 

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