Goldman: Elevated Inflation, 75bp Hike Re-Awakens The Right Tail

Goldman Sachs note that the “FOMC delivered a 75bp hike at its June meeting, with the median dot now implying a 3.25-3.50% target range by the end of this year. Our economists’ expectations for 75bp, 50bp and two 25bp hikes for the remaining meetings this year would result in the same target range by year-end, though markets are slightly ahead, pricing around 3.70% at that time and a terminal rate around 3.90% by March next year. Option-implied Fed funds distribution at the June 2023 meeting (where the terminal rate was priced post-Fed) continue to show a sharp skew to higher policy rates, though the tails are more symmetric (and fat) by YE2024, as markets are likely contemplating sizable cuts in the event of recession over that horizon. When we last updated our yield forecasts, we acknowledged the presence of significant, but symmetric, tail risks around the modal scenario. Although recent inflation developments have put the focus squarely towards the right tail - a development that we noted would raise upside risks to yields and likely warrant deeper curve inversion than in our baseline - we continue to believe this is the case. On one hand, firmer spot news and/or further evidence of upward pressure on survey measures could see an extension of recent moves. On the other hand, a larger growth slowdown than we currently envisage could put downward pressure on risk premia. Additionally, under-delivery versus inflation market pricing could also justify some moderation from current market-implied terminal rate levels. Absent firm evidence in either direction, however, we are neutral on U.S. duration at current levels.”