Higher for Longer? Goldman Sachs: It is expected that the final interest rate of this cycle will be 3.25-3.5%, 100 basis points higher than the previous cycle

Since last autumn, due to low inflation and the anticipation of a loose monetary policy by the Federal Reserve, long-term interest rates have continued to decline. However, in the latest global market commentary by Goldman Sachs economist Vickie Chang, it was pointed out that the market has been reassessing the policy path, and expectations for a Fed rate cut have been converging. The bank predicts that after this round of rate cuts, the final interest rate may reach 3.25-3.5% (currently 5.25-5.5%), which is 100 basis points higher than the peak of the previous cycle.

Higher and Longer? Mid-term interest rates face repricing

Analysts point out that since March 8th, the market has removed about 25 basis points from the expected rate cuts in 2024, totaling nearly 100 basis points since mid-January. However, the market has not made the same adjustments to its views on long-term interest rates.

Goldman Sachs believes that this indicates that the market has begun to reassess the policy path in recent weeks, retracting some rate cut expectations for 2024, but there has been no significant change in expectations for where interest rates will ultimately settle in the longer term.

Considering the stickiness of recent inflation data, Goldman Sachs believes that there is now a higher risk that long-term interest rates may continue to reprice and rise than at any other time.

Looking ahead to this week's Federal Reserve FOMC meeting, Goldman Sachs believes that investors will refocus on pricing neutral interest rates:

This week's Fed meeting may, as in the past, refocus investors on whether pricing for neutral interest rates should be higher. If the Fed's dot plot shows fewer expected rate cuts, or if the long-term dot plot starts to rise, a more hawkish outcome at this week's FOMC meeting than expected could challenge the market's view of the potential future distribution of fund rates.

The bank points out that investors need to closely monitor the potential impact of this Fed meeting on pricing neutral interest rates:

In this scenario, as in the past, it could become a catalyst for repricing long-term interest rates.

Long-term interest rates face upward risks in the future

Goldman Sachs analysis indicates that the reassessment of neutral interest rates by the market often occurs suddenly, a process influenced by the Fed's stance and US economic data.

In past cycles, long-term rates tended to price close to the upper limit of the recent policy range. For example, in October last year, the Fed indicated in its updated dot plot that it believed policy rates would remain at higher levels for longer. Subsequently, the market priced long-term rates at or above the current 5.25-5.5% fund rate.

However, later on, with weak US economic data in November and dovish signals from the December FOMC, long-term rates declined.

Goldman Sachs believes that if the Fed sticks to its median forecast of "three rate cuts" in the 2024 dot plot, but the median forecast rate in the dot plot is more likely to rise to 2.625%, and continue to rise over time, the market may reassess the longer-term policy path If the Federal Reserve believes that the policy rate at the end of 2024 is still not far from 5%, confidence in long-term forward rates in the high 3% range may weaken again. In this case, the market may change its view on the long-term policy path.

The bank believes that the ultimate rate after this round of rate cuts may reach 3.25-3.5%, 100 basis points higher than the peak of the previous cycle.

Considering that the implied volatility of 10-year and 30-year swap options is currently at a low level, Goldman Sachs suggests:

Taking a long position in longer-term swap options may be a good protection against the risk of rising long-term rates in the future