Goldman Sachs released its seven top trade themes for 2018 yesterday, November 17.
Investors and traders always receive Goldman’s trading ideas with a high degree of skepticism, knowing that the bank’s traders are perfectly comfortable trading against the expectations that these themes generate. And there’s also the belief that what Goldman is really interested in is not tradable themes but volatility.
But still, I think yesterday’s release is an important market event–because Goldman is now the first big voice willing to break with the current market consensus that the Federal Reserve will raise interest rates just twice in 2018.
Right now the market consensus is that the Federal Reserve will raise interest rates once at its December 13 meeting. And then twice more in 2018.
That consensus goes against the Fed’s own indications that it sees three more interest rate increases in 2018.
Goldman leapfrogs not just the consensus but the Fed’s sentiments too to project four interest rate increases in 2018 and a yield on the 10-year Treasury above 3% next year. On November 17, the yield on the 10-year Treasury was just 2.34%.
Why does Goldman see Treasury prices falling so hard and yields rising so fast: Inflation expectations will continue to climb, the investment bank says, and the Fed’s efforts to reduce the size of its balance sheet will put pressure on the supply of Treasuries, resulting in rising yields.
I’m more interested in Goldman’s willingness to put this view out there then I am convinced that Goldman is right about the willingness of a Federal Reserve that in 2018 will be under new management, so to speak, to push the interest rate button so many times. If doubts start to creep into the bond market and traders start to worry that the consensus might not be correct that itself will put upward pressure on yields as traders try to hedge the risk that the Fed might move more aggressively than bond prices have priced in.
Three things I’d be watching here.
First, does another influential investment bank edge toward Goldman’s call and away from the consensus? As long as it is just Goldman calling for four rate increases, I don’t see a huge effect on the bond market. If Goldman, however, is simply the first duck pin to fall, then I think we’re likely to see effects on yields, the yield curve, and the Treasuries futures market.
Second, I’d look at the inflation expectations surveys conducted by the New York Fed. After going nowhere for months, in the last few surveys expectations for future inflation have been pushing higher. That’s exactly the kind of thing that could push the Fed into unexpectedly vigorous action.
Third, I’d look to see what the Fed says if, as expected, the U.S.central bank raises interest rates on December 13. Does the Fed’s statement express enough worry so that there’s fuel for another interest rate increase relatively soon in 2018?
I spend so much time on interest rates and the Fed because I think “lower for longer” is a key underpinning for the long rally that we’re now enjoying in stocks. Modify that rationale and I think it becomes necessary to modify your beliefs on risk and reward in this market.