Treasury Bond ETFs Fall as Goldman Sachs Says Rate Cuts Are Coming in 2024

Exchange-traded funds (ETFs) that invest in U.S. Treasury bonds with extended maturities witnessed a decline on Monday after experiencing three consecutive weeks of losses. This drop comes as analysts from Goldman Sachs Group foresee the possibility of the Federal Reserve implementing interest rate cuts next year.

‍

Goldman Sachs' U.S. economic analyst, David Mericle, suggested in a research note dated August 13 that the Federal Open Market Committee (FOMC) might decide to lower rates due to factors such as a potential recession, a modest growth concern, or a substantial decrease in inflation. Mericle emphasized that their baseline forecast points towards the FOMC commencing federal-funds rate cuts during the second quarter of 2024. However, these rate cuts are driven by a desire to normalize the funds rate from a restrictive level once inflation approaches the target, rather than being triggered by a recession.

‍

While the Federal Reserve has been gradually increasing interest rates this year to counter lingering inflation that surpasses its 2% target, ETFs focused on long-term Treasury bonds have experienced losses in 2023. These declines have occurred amidst the backdrop of a robust U.S. economy supported by the central bank's continued tightening of monetary policy.

‍

Mericle noted that the impetus for rate cuts doesn't primarily stem from the motive of normalization and that there is also a significant likelihood of the FOMC maintaining a steady stance.

‍

In the meantime, the Vanguard Long-Term Treasury ETF (VGLT) and iShares 20+ Year Treasury Bond ETF (TLT) each registered a 0.2% decline on Monday. The iShares 10-20 Year Treasury Bond ETF (TLH) experienced a roughly 0.1% drop. These ETFs all recorded consecutive weekly decreases, contributing to their year-to-date declines.

‍

So far in 2023, the Vanguard Long-Term Treasury ETF has experienced a total return loss of 1.9% through August 11, while the iShares 20+ Year Treasury Bond ETF encountered a 2.4% reduction. The iShares 10-20 Year Treasury Bond ETF declined by 1.2% during the same period, based on total return data.

‍

When U.S. government bond prices decline, yields on Treasurys rise. The yield on the 10-year Treasury note increased by 1.5 basis points on Monday, reaching 4.181%. This followed four consecutive weeks of upward movement. Shorter-term yields, such as the 2-year Treasury rates, also witnessed an increase of seven basis points on Monday, reaching 4.963%, which marked the highest level since July 6.

‍

While Goldman Sachs' baseline forecast anticipates rate cuts by the Fed next year, Mericle expressed a degree of uncertainty regarding whether the central bank will indeed take such actions. He remained skeptical of New York Fed President John Williams' recent remarks in an interview, where Williams argued that if inflation subsides, not cutting interest rates next year could lead to an undesirable increase in real interest rates.

‍

Mericle highlighted the skepticism that Goldman Sachs has held regarding this argument since early last year. He emphasized the importance of considering forward-looking inflation expectations, and he also noted that the funds rate itself might not be a primary determinant of economic activity.

‍

In July, the Fed raised its benchmark rate by a quarter of a percentage point to a target range of 5.25% to 5.5%, reaching the highest level in 22 years.

‍

Within Goldman's forecast of future Fed rate reductions, the motivation is centered around moving closer to neutral rates as inflation subsides, rather than stimulating the economy in response to a negative shock. The research note outlined the possibility of 25-basis-point cuts per quarter in this scenario, while acknowledging uncertainty about the pace.

‍