Goldman: Transition To Lower Vol Regime Deferred, Not Derailed, Tweak Recommendation

Goldman Sachs write “while some of the implied vol decline we anticipated (on end of Fed tightening and lower worry re: debt vs. interest rate levels) did materialize over 2023, the magnitude of the drop has been smaller than we had anticipated because of two shocks: first, the failure of SVB, and second, the long end-led selloff over the summer.”

• “Looking ahead into 2024, we believe the transition to a lower vol regime that we anticipated for this year is set to resume, and in our baseline soft landing view, both implied and realized rate vols across the surface should decline from current levels.”
• “Term premium repricing at the long end has resulted in a pick-up in longer tenor vols; implied vols on 10y tails remain quite elevated, with straddle breakeven ranges over the next year wider than the range we expect 10y yields to trade in.”
• “We have also argued that front end volatility had been too elevated, with the policy rates constrained to the downside by modestly above target inflation and to the upside by policymaker fear of overtightening.”
• “In addition to declining vols across tenors, we also continue to believe the vol curve should steepen. This has happened to some extent, and will likely extend, but we recommend taking profits on our 1y2y/1y10y vol curve steepeners trade.”
• “That is because we believe there is sufficient vol premium at longer maturities that is attractive to monetize - we recommend selling 6m10y straddles.”