Goldman Sachs sees September Fed rate hike as very unlikely

Highlights

Goldman Sachs says Fed hike bets remain too hawkish.
Softer U.S. data reduce the case for higher rates.
Short-term Treasury yields could fall further.

According to Bloomberg, traders have already pushed expectations for the next quarter-point increase to January after fully pricing a December move only a week earlier. Goldman believes that adjustment has further to run, leaving short-term Treasury yields vulnerable to additional declines if incoming economic data remain soft.

Softer data reshapes the rate outlook

The change in expectations follows two months of weaker labor market and inflation readings. Goldman chief economist Jan Hatzius expects those developments to make it difficult for policymakers favoring a cautious approach to monetary policy to support higher rates this year.

The repricing has already reached the Treasury market. Two-year yields, which respond closely to changes in expectations for Fed policy, have moved lower as investors reduce near-term tightening bets, though they remain above 4%.

That does not mean the entire bond market is positioned for a straightforward rally. Longer-term Treasury yields face a different set of pressures as heavy government borrowing and concerns about the U.S. fiscal position increase the compensation investors demand for holding longer-dated debt.

Goldman therefore expects the Treasury yield curve to steepen further. Softer inflation and declining expectations for Fed tightening could pull down yields at the short end, while fiscal concerns may keep longer maturities under pressure.

The bond market is looking beyond the Fed

The debate matters well beyond the timing of the next Fed meeting. U.S. monetary policy influences borrowing costs across global markets, making changes in expectations for the federal funds rate important for government bonds, currencies, and corporate financing.

The more complicated question now sits at the long end of the Treasury curve. Cooling inflation would normally support bonds, but large government financing requirements could prevent long-term yields from falling at the same pace as shorter maturities.

That divergence is central to Goldman’s outlook. With two-year Treasury yields still above 4% and traders shifting the expected timing of the next quarter-point increase from December to January, the market has already become less aggressive about further tightening. Goldman’s argument is that investors have not gone far enough.

We have previously highlighted that Fed officials push for a rate hike to rein in inflation.

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