The market is reassessing the likelihood of an imminent Fed rate hike — Goldman Sachs

Goldman Sachs warned that investors’ expectations of further monetary tightening by the U.S. Federal Reserve remain excessive, even as inflation in the world’s largest economy is slowing. The bank’s stance is also significant outside the U.S.: the Fed’s decisions set the cost of money across the entire debt market.

A rate hike at the Fed’s September meeting has become “extremely unlikely” following weak retail sales and employment data, as well as a slowdown in inflation. Goldman Sachs Chief Economist Jan Hatzius made this assessment in a note to clients on August 16, according to Bloomberg. In the bank’s baseline scenario, inflation figures are “more likely to continue improving than to deteriorate again” by the end of the year.

The Federal Reserve’s (Fed) interest rate path is important for the entire government debt market: the U.S. central bank’s decisions influence interest rates around the world. The money market currently puts the probability of a 25-basis-point rate hike in September at 27%, according to LSEG data cited by The Wall Street Journal. The next such move is not fully priced in until January, although just a week ago, December was the benchmark, Bloomberg reports.

A reassessment of the economic outlook has caused U.S. Treasury yields to move in different directions. Last week, yields on short-term Treasuries—which are most sensitive to Fed decisions—fell, while yields on long-term Treasuries rose: investors are demanding higher compensation for financing the growing U.S. budget deficit, according to Bloomberg.

Goldman expects the spread between short- and long-term bond yields to widen further due to an improving inflation outlook and a decline in the risk premium for rate hikes. After two months of slowing inflation and a cooling labor market, doves on the Fed are unlikely to support a rate hike, according to Hatzius.

Bloomberg notes that government bond holders are currently caught between two opposing forces. On the one hand, slowing inflation typically supports bond prices. On the other hand, heavy borrowing by the U.S. government and concerns about the budget are keeping yields on long-term bonds high and preventing their prices from rising.

On Wednesday, August 19, the market will receive two key indicators at once. The first is the minutes from the Fed’s July meeting, at which the central bank voted 9–3 to keep the federal funds rate in the 3.5–3.75% range. The document will be closely scrutinized to gauge the extent of disagreement within the Fed, The Wall Street Journal reports, citing Capital.com analyst Daniela Hothorn.

On the same day, the U.S. Treasury will issue $16 billion in 20-year bonds. The benchmark yield on these bonds reached 5.27% by the end of last week. If this level holds, the yield on this issue will be the highest since 20-year bonds returned to the market in 2020, according to Bloomberg. A week earlier, the Treasury had already set new records: 30-year Treasuries sold at the highest rate in a quarter-century, and the yield on 10-year Treasuries was the highest since 2007.

This article was AI-translated and verified by a human editor