Goldman Sachs believes that slowing inflation is the optimal route to lower US Treasury yields, and consequently, a Federal Reserve interest rate hike in September is "very unlikely." This assessment comes from Chief Economist Jan Hatzius, who noted that market expectations for future rate increases are still too aggressive given the persistent deceleration in inflation.
Hatzius's analysis, detailed in a recent note, points to several underwhelming economic readings, including sluggish retail sales, weaker jobs numbers, and decelerating price pressures, as reasons for skepticism regarding a September rate hike by the Federal Open Market Committee. He emphasized that after two months of materially softer jobs and inflation data, it would be difficult for any of the more dovish members of the committee to advocate for hikes.
Goldman's baseline forecasts anticipate further improvement in inflation rather than a renewed deterioration. Hatzius stated that under these economic forecasts, inflation news is more likely to continue improving throughout the year. He also reiterated that the market's current pricing for the federal funds rate remains too hawkish. CME FedWatch data indicates a roughly 30% chance of a 25-basis-point increase to the 3.75%-4% target range for the September meeting, a significant shift from the prior week's expectation of a December move.
The bank also highlighted that the US Treasury yield curve is poised to steepen. This anticipated shift is attributed to cooling price pressures, diminishing expectations for rate hikes, and growing concerns about the fiscal outlook. Despite these factors, two-year Treasury yields, which are highly sensitive to Fed policy changes, are still above 4%.
