The global investment bank Goldman Sachs has stated that market bets on the Federal Reserve raising interest rates are still too aggressive, given that inflation in the world's largest economy is cooling. In a client note, Goldman Sachs Chief Economist Jan Hatzius wrote that a September rate hike by the Fed is "very unlikely" following weak US retail sales data, disappointing employment figures, and slowing inflation data.
Hatzius noted in the report released on Sunday, "Based on our baseline economic forecast, inflation news is more likely to improve further over time rather than worsen again. We still believe the market's pricing of the federal funds rate is too hawkish." Data shows that traders have pushed back expectations for the next 25-basis-point rate hike by the Fed to January next year, whereas a week ago they were fully pricing in a December move.
Goldman Sachs indicated that despite some easing in market hawkishness, there is still room for rate hike expectations to decline. Given that US policy moves often influence global interest rates, the Fed's actions are crucial for global government bond markets. Currently, US Treasury investors face a dilemma: cooling inflation boosts the appeal of holding Treasuries, but massive government borrowing and persistent fiscal concerns force investors to demand higher returns for holding long-term bonds.
Analysts suggest that while short-term yields may benefit from reduced expectations of rate hikes this year, long-term yields remain vulnerable. This tension could keep long-term yields elevated even as price pressures ease, dampening the rally typically associated with slowing inflation. The yield on the 2-year US Treasury note, most sensitive to US policy changes, remains above 4%, as investors weigh when and whether the Fed will raise borrowing costs again.
Goldman Sachs' report added that the US Treasury yield curve could steepen further due to improved inflation, a lower premium for rate hikes, and negative fiscal budget news. "After two consecutive months of significantly weak employment and inflation data, it's hard to see any dovish shift toward raising rates," Hatzius wrote, referring to the Fed officials who vote on interest rates this year.
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