Goldman Sachs has warned that bond markets may be too focused on inflation and not focused enough on the risk of a deeper growth scare, arguing that downside risks to yields are now underpriced after the latest surge in energy-driven volatility.
In a new rates volatility note, the bank's analysts said March’s inflation shock has so far been traded along hawkish lines, but that only tells part of the story.
Goldman said a sufficiently large rise in energy prices would eventually shift attention away from sticky inflation and towards demand destruction and weaker growth, a combination that could drag yields lower and keep volatility elevated. “We think downside risks to yields have risen and are underpriced,” the analysts wrote.
That leaves Goldman cautious on outright volatility selling in US rates, even after implied vol has reset higher. Instead, it favours more selective positioning.
Analysts reckon the receiver spreads remain its preferred limited-risk hedge against a left-tail outcome, while the recent repricing in payer skew could also be faded through risk reversals rather than by selling vol outright.
It noted that 2-year US Treasury risk reversals are now at their lowest since the height of the hiking cycle, suggesting markets are still paying up for protection against higher yields while giving too little weight to labour-market or growth downside.