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1、,October 26,2012Fixed Income MonthlyEconomics ResearchAt the Edge of the Fiscal Cliff,Improving Cyclical Momentum Should Push Yields HigherWe expect government bond returns to be driven primarily by developmentsin real economic activity over the next 3-6 months.Our business cycleleading indicators p
2、oint to a sequential improvement in growth,admittedlyfrom low levels.We also foresee a further relaxation in European riskpremium,following the activation of bond purchases by the ECB.,Francesco Garzarelli+44(20)7774-5078 Goldman Sachs InternationalSilvia Ardagna+44(20)7051-0584,Goldman Sachs Intern
3、ationalBond Market Priced for Bad US Growth Outcomes,We assess the risks to our rate views emanating from the US fiscal cliffnegotiations.We conclude that the bond market is already priced for aBad outcome,consistent with tighter fiscal consolidation(1.6%of GDP)than our baseline case(1.1%of GDP).The
4、 outcome of the US presidentialelections will provide more clarity on the likelihood of the differentscenarios.Tactical Trades We LikeWe are currently recommending two tactical trades:(i)Short 10-yearUS$OIS against long 10-year EONIA;and(ii)Outright short 5-year Frenchyields.The Market is Pricing a
5、Bad Fiscal Cliff Outcome,George Cole+44(20)7552-3779 Goldman Sachs International,10-year US Bond Yield ForecastsGS baseline end 2013Forward October 2013Range in Alternative Fiscal ScenariosThe BadThe Ugly,Yield(%)2.52.01.7-1.91.25-1.5,Note:The lower end of the range is computed from current the US 1
6、0yr yield.The upper range iscomputed from our end-2012 forecast for the US 10yr yield of 2%.Source:Consensus Economics,Bloomberg and GS Global ECS ResearchInvestors should consider this report as only a single factor in making their investment decision.For Reg AC certificationand other important dis
7、closures,see the Disclosure Appendix,or go to,The Goldman Sachs Group,Inc.,Goldman Sachs,1.,2.,2,October 26,2012,Fixed Income Monthly,Why Bond Yields Can Increase FurtherWe expect government bond returns to be driven primarily by developments in realeconomic activity over the next 3-6 months.Our bus
8、iness cycle leading indicatorspoint to a sequential improvement in growth,admittedly from low levels.We alsoforesee a further relaxation in European risk premium,following the activation ofbond purchases by the ECB and a modification of official-sector loans to Greece.Overtime,this should lead to fo
9、reign flows back into the larger peripheral markets.Earlysigns of this are already visible.1.Why Bond Yields Havent Increased Much.Government bond yields in the major markets(US,Germany and Japan)have increased inresponse to a sharp compression in the European risk premium and better-than-expectedma
10、cro data.For example,7-to-10-year German Bunds and US Treasuries have sold off byaround 40bp from their lows in the third week of July(resulting in period total returns ofaround minus 2%-3%).However,intermediate yields remain at least 30bp-50bp below the levels seen between thesecond half of 2011 an
11、d the first quarter of this year,and remain well below our forward-looking macro factor measures of fair value.A phase of consolidation in bond markets was what we presented as our centralexpectation in the September issue of this publication.Our argument was based on threeobservations:Financial sec
12、urities more directly affected by EMU sovereign risk moved upconsiderably in value over the Summer.The move was triggered by a policy shift(namely,the launch of the OMT framework)and amplified by short-covering.Butwe are yet to witness a material reversal of asset allocation decisions that have ledg
13、lobal institutional investors to shy away from non-core Euro area markets.There has been an intervening relaxation of monetary policy around the world,with many central banks either cutting,or signaling further easing,in response toperceived downside risks to activity growth.More broadly,low yields
14、are acharacteristic of recoveries from balance sheet recessions,as discussed in GlobalEconomics Weekly 12/30 Why this Rally is so Defensive.,Exhibit 1:Market Tepid on Growth OutlookDefensive sectors include:consumer staples,consumerdiscretionary,health care,telecoms;Cyclical sectors include:industri
15、als,materials,IT,financials.,Exhibit 2:Defensive Sectors in High Demand,1.1,Index,1.00,%,4.0,1.0,3.5,0.90.8,0.950.90,Index,3.02.5,0.72.0,0.6,0.85,0.5,S&P 500US cyclicals vs defensives,S&P 500 vs DefensivesUST 10y yield(RHS),1.5,0.42008,2009,2010,2011,2012,0.802010,2011,2012,1.0,Source:GS Global ECS
16、ResearchGoldman Sachs Global Economics,Commodities and Strategy Research,Source:GS Global ECS Research,GLIAcceleration,Mar-12,3.,3,October 26,2012Exhibit 3:GLI Swirlogram:Shift to Expansion,Fixed Income MonthlyExhibit 4:G3 Bond Yields Lagging the Cycle,0.15%,Recovery,Oct-11,Nov-11,Expansion,3.9,%,%m
17、om,0.8,0.10%0.05%0.00%-0.05%,Aug-12Jul-12Jun-12May-12,Oct-12Sep-12,Dec-11Jan-12,3.42.92.4,0.60.40.2,-0.10%,Feb-12,0.0,-0.15%Contraction-0.20%-0.4%-0.3%-0.2%-0.1%0.0%0.1%,Apr-12,GLI Growth,0.2%,Slowdown0.3%0.4%,1.91.4Jan-10,G-3 avg.10-yr bond yields(LHS)Global Leading Indicator(RHS)Jul-10 Jan-11 Jul-
18、11 Jan-12,Jul-12,-0.2-0.4,Source:Goldman Sachs Global ECS Research.,Source:Goldman Sachs Global ECS Research.,At least two sources of tail risk continue to hang over markets:the possibility thatthe US economy could fall off the fiscal cliff in early 2013,and thus precipitate arecession(we expand on
19、this topic in the next section).And the ongoingquestioning of Greeces(and increasingly Cypruss)future in the Europeanmonetary union.The Greek government is still discussing the adjustment plan withthe troika,while Cyprus is in talks about a bailout supported by EMU countries andRussia.This combinati
20、on of factors may explain why bond yields are where they are.But theimportant question is what comes next.2.And Why We Think They Will Go HigherWe are increasingly of the view that upward pressures on intermediate yields will becomemore manifest in coming months,in tandem with an outperformance of g
21、rowth-sensitivesectors of the equity market.We currently recommend positioning short US$10-year ratesagainst their counterparts in EMU,and long cyclical stocks against defensives in theS&P500(formalized through the GS Wavefront basket).An even more pro-cyclical tilt looksto us increasingly appropria
22、te.Looking ahead,we note the following:Economic activity:Our leading indicators of economic activity have started toturn upwards.Our proprietary Global Leading Indicator is now showing positiveand accelerating momentum for the first time in around one year.In the past,wehave noticed that G-3 bond yi
23、elds respond with a lag at turning points in the GLI.But they do eventually tend to move in the same direction:a higher GLI isassociated with higher 10-year yields(in 4Q2011,the European sovereign crisisinterrupted a pattern).In this context,it is also interesting to observe that our USMAP Index,whi
24、ch tracks the rolling difference between expectations andrealizations on macro data(weighted by their relevance to asset price returns)started to increase in July and is now in positive territory.Goldman Sachs Global Economics,Commodities and Strategy Research,1,4,October 26,2012Exhibit 5:10y Bunds
25、Tick up as TARGET2 Claims Stabilize,Fixed Income MonthlyExhibit 6:Valuation Supports Stocks Over Bonds,4.54.0,%,EUR bn,0-100,76,%,Germany:risk premium on DAX vspremium on 10y bunds,3.53.02.52.0,-200-300-400-500-600,543210-1,20 year average,2 std dev band,1.5,German 10-yr benchmark yield(lhs)Bubas ne
26、t creditor position(rhs),-700,-2,1.0Aug-08,Aug-09,Aug-10,Aug-11,Aug-12,-800,-3,90,92,94,96,98,00,02,04,06,08,10,12,Source:Bundesbank,GS Global ECS Research,Source:GS Global ECS Research,Central bank policy:With short-term policy rates at zero,and long-dated realrates already in negative territory in
27、 both the US and Europe,central banks havedirected their focus to the credit channel.The Feds open-ended purchase ofmortgage-backed securities,the ECBs interventions in the peripheral sovereignmarkets and the Bank of Englands funding-for-lending scheme all fit into thisbroad picture.Signs of a respo
28、nse in the mortgage activity are already evident inthe US and the UK.The extent to which the ECBs OMTs will help revive theprivate credit market in the South of Europe remains to be seen,but it is difficult tothink that the effect will be negative.Valuations:As we discussed recently1 the differentia
29、l between the equity riskpremium and the bond risk premium is now at multi-decade highs.We wouldexpect an increase in bond yields in the region of 30bp-50bp above the current 3-month forwards not to take the shine off stocks,particularly if led by an upward re-rating of growth expectations.Allocatio
30、n into EMU peripherals:We expect Spain to apply for an EnhancedConditions Credit Line from the ESM in the coming weeks(see accompanying box).This should unlock the ECBs Outright Monetary Transactions(OMTs)and supporta slow reallocation of funds into peripheral markets,leading to a compression inintr
31、a-EMU rate differentials.In this context,the Bundesbanks TARGET 2 net claimsagainst the rest of the Eurosystem have started to turn.This represents anindicator of the distribution of liquidity across the Euro area,and the inversecorrelation with German Bund yields is worth tracking(see Exhibit 5).Th
32、ere issome evidence that funding terms for the larger southern European banks areimproving,as foreign interest picks up.See Germany:The Case for Stocks over Bonds,Global Markets Daily,October 9,2012Goldman Sachs Global Economics,Commodities and Strategy Research,1.,2.,5,October 26,2012Exhibit 7:Spai
33、n:Fundamental Spread to Germany9,Fixed Income MonthlyExhibit 8:Italy:Fundamental Spread to Germany9,8765,%,Fundamental Spread to DEMPre-Draghi Speech(24/07)Current,8765,%,Fundamental Spread to DEMPre-Draghi Speech(24/07)Current,43,43,2,2 std dev band,2,10,10,2 std dev band,2Y,3Y,4Y,5Y,6Y,7Y,8Y,9Y,10
34、Y,2Y,3Y,4Y,5Y,6Y,7Y,8Y,9Y,10Y,Source:GS Global ECS Research,Source:GS Global ECS Research,Tail risk:This is admittedly the harder part to have a strong opinion on,given thepolitical dimension involved.Pressures on the US Congress to reach acompromise on the fiscal cliff and the debt ceiling in the l
35、ame duck session haveincreased,but this remains an area of significant risk and uncertainty.That said,aswe discuss in the next section,we think that worse outcomes on the resolution ofthe fiscal impasse than envisaged by our baseline case are already reflected in USforward rates.Disbursement of a fu
36、rther tranche of EFSF aid to Greece(a largepart of which will be used to recapitalize the domestic banks),alongside a furthermodification of the Greek Loan Facility and an activation of a rescue plan forCyprus,could allay concerns about a near-term escalation of systemic risk.Heretoo,however,absent
37、more radical choices over debt forgiveness(Greeces EMUpeers account for around two-thirds of the countrys debt stock)and a growthstrategy,the viability of Greece in the Euro area will remain in question.What is a realistic expectation for the path of 10-year bond yields?Our macro estimatessuggest th
38、at they should currently trade at around 2.5%in the US,2.0%in Germany and1.0%in Japan(a full list is available on pp.14-15).Using our economists baseline macroforecasts,we project the fair value to move up modestly to 2.75%in the US,2.25%inGermany and 1.4%in Japan by end-2013.If spot yields were to
39、converge to these levelsover the next 15 months,total period bond returns would be in the region of-3%.Particularly in the US,bond yields have not been so stretched from a valuation standpointsince October 1998.Francesco U.GarzarelliCurrent Rates Trading RecommendationsPay US 10-year OIS swaps and r
40、eceive 10-year EONIA swaps,opened at-7bp on30 July 2012,with an initial target of 50bp and a stop on a close below-10bp,nowat 7.3bp.Stay short 5-yr French bonds,opened at 0.96%on 20 Aug 2012,with an initialtarget of 1.5%and a stop on a close below 0.70%,now at 0.92%.Goldman Sachs Global Economics,Co
41、mmodities and Strategy Research,6,October 26,2012,Box 1:Supporting Spains Funding Needs,Fixed Income Monthly,OptionDraw Down:Spaincan take down thefunds with a weeksnotice and replaceprivate market primaryissuance.Primary MarketPurchase:Spain canask the ESM toparticipate at regularauctions,alongside
42、private investors.Partial ProtectionCertificate:Spain canattach to newly issuedbonds,detachablecertificates of 20%-30%first loss insuranceissued by the SovereignBond ProtectionFacility.CIF:Spain can benefitfrom primary andsecondary purchasesdone by a sovereign co-investment fund(Sovereign Co-Investm
43、ent Facility).,CommentThe ESM has already pledged EUR100bn to Spain tosupport the recapitalization of domestic banks.Weexpect around EUR60bn to be used.An additionalEUR50bn would cover net issuance into 2014.The ESMfunds earmarked for banks are pari passu with existingbonds;it is unclear whether thi
44、s would apply for a top-up.The vehicles can purchase up to 50%of each issuance.The EFSF/ESM would participate at the weighted-average price of the auction.Spain can choose whereto cut the private bids.In syndicated transactions,theEFSF/ESM would purchase bonds at the re-offer price.The EFSF/ESM has
45、discretion as to how to manage theportfolio(sell back into market,repo,etc.).All costs inconnection with the PMP are shouldered by Spain.The first loss protection certificates(on ISDAsdefinition of market event)are currently part of thetoolkit of the EFSF only.Legal work is still being carriedout to
46、 transfer these instruments to the ESM.Thecertificates will be zero coupon bonds matching thematurity of the principal of the security they are issuedwith.They can be stripped and traded freely.They willbear the name of the ESM(rated AAA).Work also isbeing done to ensure that these ESM certificates
47、areeligible as ECB collateral.A CIF(SPV)will have three tranches:first loss,atradable participating tranche and senior debt(targetAA/A rating).The first loss trance would beremunerated at the ESM cost of funds.It will have apre-defined lifetime during which it can purchase inboth primary and seconda
48、ry markets.It has someflexibility to sell bonds.,Likely Market Impact Most straightforward option,canbe used as backup,and limitissuance at the long end of thecurve.Ideally loans have maturitylonger than average life of debt(i.e.,10-yr plus).Potential uncertainty/confusionaround the auction results.
49、Risk ofdowngrades if market access isseen as impaired.Small credit uplift,based onCRA methodologies.May increasemarket segmentation.There areissues with the definition of a creditevent,e.g.,a voluntary PSI andcherry picking.The interactionbetween CACs and detachment ofthe guarantee needs considerati
50、on.Senior investors would accessa levered return with lower risk.Good signaling effect if foreignbuyers(e.g.,SWFs)can be broughtback to the European peripheralmarket.Particularly effective ifdirected towards the primary market.,For more detail on EFSF/ESM funding program guidelines,see:http:/www.efs
