Higher long-term volatility lurks in widening spread of interest rate forecasts

Today Goldman Sachs projected that the yield on the Treasury 10-year note will climb as high as 3.5% in the next six months. In addition, the Wall Street giant told Bloomberg, the U.S. Federal Reserve will raise rates four times in 2018. The yield on the 10-year Treasury finished at 2.85% yesterday after trading as high as 2.89%, a four-year high.

This is important not because Goldman Sachs is always right–in fact the company seems to intentionally make forecasts outside the consensus–but because the call widens the spread of forecasts on Wall Street. And the wider the spread of forecasts the more volatility that introduces into the financial markets.

Think about it this way: The consensus on Wall Street was that the Fed will raise its benchmark interest rate two to three times in 2018.   Yields will climb to 2.95% by September, according to the median forecast of Wall Street analysts surveyed by Bloomberg. That survey says the the 10-year yield will reach 3.5% by the second quarter of 2020. No one knows, of course, how many times the Fed will raise rates in 2018 or how high yields will go, but with this consensus volatility bounces back and forth in a range from 2-3 rate moves and a yield forecast centered around 2.95%. If you expand the possible outcomes, and a call by a Wall Street institution with Goldman’s clout does just that, then the financial markets bounce between 2 and 4 rate moves and have to include that possibly of 3.5% in its swings. Voila! More volatility.

Not that the financial markets, especially the bond market, need more volatility. There’s already huge uncertainty surrounding the pace at which the Federal Reserve will act and worry about a potential policy mistake as global central banks shift from buying financial assets to selling debt instruments out of their portfolios. There’s a general recognition that we’re at a major turning point in monetary policy at the central banks in the developed world after year and years of quantitative easing put in place to fight the Great Recession that followed on the global financial crisis.

The 10-year U.S. Treasury note volatility index (TYVIX) hit its highest level since April last week. In data through February 6, the Commodity Futures Trading Commission reports that short-bets in the 10-year Treasury futures market rose to a record 939,351 contracts.