Goldman: Macro Data Trim The Policy Tails, Argues For Higher Yields

Goldman Sachs note that “recent data have supported a reduction in the probabilities of both the upside and downside scenarios for interest rates.”

• “But by allowing the Fed to proceed with tightening at a more deliberate pace, the moderation in price pressures also reduces the risk of significant overtightening that would warrant subsequent easing, given our view that lags with which monetary policy affects growth are shorter than commonly assumed.”
• “Additionally, we believe continued strength in the labor market, as seen in the very strong January jobs reports, will make it fairly unlikely that the Fed will deliver anywhere close to the amount of easing investors currently appear to be anticipating, even if the comparatively optimistic outcome inflation markets are implying is realized.”
• “We note that the strengthening case for pricing a narrower path for the policy rate around our projected 5-5.25% peak level translates to higher longer maturity yields. That is because the longer the economy is able to operate at the higher policy rate setting, the more likely investors are to conclude that medium term rates - a proxy for equilibrium levels that currently trades at a roughly 200bp discount to the policy rate - are mispriced. At the very least, we think investors will become less willing to accept the still significantly negative risk premium implicit in longer maturity bonds.”