Goldman Sachs: Higher Rates, Wider Spreads, Steeper Credit Curves

Goldman Sachs note that "sovereign spreads have widened modestly in recent weeks as the market has revised higher its issuance expectations for 2021. We now expect an area-wide deficit larger than that of 2020, at 7.8% of GDP. Based on the substantial revision higher in the Italian deficit, and using our estimates of the sensitivity of yields to changes in the 'free float' (private sector holdings share) of bonds, we expect to see another 10bp widening in BTP-bunds. Beyond issuance, our macro models suggest growth will be an imperfect substitute for policy support, which is unlikely to become much more dovish from here. We still see short European duration as the better expression of the cyclical recovery in Europe, and expect another 20bp sell-off in 10-Year bunds. That said, we do think there's an argument for shortening duration on sovereign credit exposures, as our valuation framework points to a 10-20bp steepening in the 2s10s credit curve in Italy and Spain. Ahead of a rising focus on the French election in the second part of the year, we continue to expect modestly wider spreads at the 10-Year point, and revise our year-end 10-Year sovereign spread targets to 30bp for OAT-bunds, 70bp for Bonos-bund, and 120bp for BTP-bunds spreads."