Bond markets underestimating the Fed, Goldman and Pimco warn

The firms say bonds are poised to fall and traders aren't prepared for how far the Federal Reserve will raise interest rates.

Goldman Sachs Group Inc. and Pacific Investment Management Co. say bonds are poised to fall and traders aren’t prepared for how far the Federal Reserve will raise interest rates.
“Ten-year yields are likely to go up,” Jan Hatzius, chief economist for Goldman Sachs, said at a conference in Sydney. The “bond market is underestimating to a significant degree the amount of monetary normalization that we’re likely to see.” The benchmark yield will rise to about 3% by year-end, he said, from 1.91% Thursday.
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Global economic growth will subdue deflation fears, and the Fed will raise rates more than traders expect, according to Pimco, which manages the world’s biggest actively run bond fund. The company has a “small underweight” position in global bonds, according to a report Wednesday by Mihir P. Worah and Geraldine Sundstrom, fund managers at the Newport Beach, California, firm.
The two bond powerhouses are voicing the consensus outlook among economists surveyed by Bloomberg, which projects yields will rise through the course of 2016. The bearish view is reemerging after being drowned out in January as tumbling oil and stock prices sent investors rushing to the haven of government debt.
LOWEST LEVEL
The Treasury 10-year note yield rose two basis points, or 0.02 percentage point, to 1.91% as of 6:36 a.m. in New York Thursday, according to Bloomberg Bond Trader data. The price of the 2.25% security due in November 2025 was 103 2/32. The yield dropped to 1.79% Wednesday, the lowest level since February 2015.
Bond traders see less than a 50% chance the Fed will raise rates in 2016, based on futures contracts. When policy makers met in December and increased their benchmark for the first time in almost a decade, they indicated there would be four more moves this year.
The rationale for higher yields is “quite strong,” Goldman Sachs’s Mr. Hatzius said. “Recent news, of course, has been somewhat softer so there’s some downside risks to that.”
Early in 2015, with the Treasury 10-year yield at about 1.90%, Mr. Hatzius predicted it would jump to 2.85% by the end of that year. The yield ended December at 2.27%. Goldman Sachs is one of the 22 primary dealers that trade directly with the Fed.
FUNDAMENTALS INTACT
Pimco’s Jerome Schneider says bond traders shouldn’t write off Fed rate increases this year. He and his colleagues predict policy makers will raise their target more than once in 2016 as U.S. economic growth remains stable and wage gains pick up.
“The fundamentals of the U.S. economy remain fairly intact,” Mr. Schneider said in an interview in New York. “Not to say we are going to have successive Fed hikes. It will be under four hikes.”
Data due later Thursday will show jobless claims for the week ended Jan. 30 held near the same level as the previous week when they dropped from a six-month high, according to the median forecast of economists surveyed by Bloomberg. A report on Friday will show employers added 190,000 jobs last month after 292,000 in December, a separate survey indicated.
Mr. Schneider’s $13.8 billion Pimco Short-Term Fund gained 1.4% last year, while rivals in the same category were flat on average, data compiled by Bloomberg show. The performance helped lead Morningstar Inc. to name him and his team fixed-income fund manager of the year last week.
Pimco faced growing outflows after co-founder Bill Gross was ousted in 2014. Withdrawals from the Total Return Fund, which Gross managed, reached over $200 billion relative to the peak in assets in 2013. The $89.3 billion Pimco Total Return Fund has fallen 0.7% in the past year, ranking in the middle of its peers, based on data compiled by Bloomberg.