Goldman: Upside Risks To Yields, But Moving Beyond Peak Inversion

Goldman Sachs note that “market pricing is roughly aligned with our Fed baseline through year-end, and 10-Year yields sit right around our current YE22 forecast of 3.30%.”

• “Nonetheless, we see upside risks to longer dated yields from a higher realized terminal rate in the current economic backdrop. This is mainly because investors, in our view, appear to be placing material odds on scenarios that involve significant easing from the peak, to a degree that is incongruent with Fed commentary if current inflation pricing were to realize.”
• “Under a soft landing baseline, we think forward points should trade at a smaller discount to the peak rate. Longer horizon forwards can also reset higher as investors update their long run rate priors in the event of a ‘normal’ growth outcome at a higher policy rate setting.”
• “Finally, we think higher yields should be primarily driven by the real component, most notably at nearer-term forward points (more on this below), but also further out to some extent.”
• “A slowing in the pace of Fed tightening after a 75bp September hike, coupled with the expectation that growth can rebound next year alongside inflation that is closer to target, suggests that ‘peak curve inversion’ for the cycle is likely behind us.”