Goldman Sachs: Front-End Repricing Drags Forward Yields Higher

Goldman Sachs note that “as markets have priced a steeper (and front-loaded) Fed rate hike path, the forward curve has continued to flatten (and even invert in some parts). Although front end-led, the rapid curve flattening has also been accompanied by a notable shift higher in intermediate and longer dated forward points, with a relatively parallel upshift in pricing beyond a 3-year horizon. While the flattening has happened more rapidly than our forecasts imply, this dynamic is broadly reflected in our yield projections, which has yields in the portions of the curve that are flat (or mildly inverted) move higher gradually relative to the front end, and in a near-parallel fashion. We note that that while our nominal Treasury forecasts do not show curve inversion, a flat UST curve would correspond to a firmly inverted swaps curve given the term structure of swap spreads (2s30s OIS swap spread curve is currently about -42bp). As the Fed progresses through its hiking cycle, we expect any further upward pressure in the front end will continue to manifest as smaller upshifts in the flat/inverted portions of the curve, leading to further flattening and/or inversion. However, once the policy rate is close to having caught up with nearer dated forwards, barring a clear indication the Fed is moving into restrictive territory, we believe longer-dated forwards will begin to move more in lock-step, i.e., with a higher beta to the policy rate.”