U.S. Treasury market "dramatic change": "Inflation concerns" outweigh "rate cut expectations"

As the global bond market undergoes intense sell-offs triggered by inflation panic driven by soaring energy prices, Goldman Sachs warns in its latest "Global Rates Trader" report: The market is mispricing.

In the report, Goldman Sachs’ rates strategy team paints a picture of global bond markets being unilaterally dominated by inflation fears: due to Middle East geopolitical conflicts and energy supply shocks, major central banks around the world are collectively sending hawkish signals, causing short-term rates to surge. "Inflation concerns" have completely taken over current trading logic.

However, the team believes that the continued sell-off of Fed terminal rate pricing is already "inconsistent with the nature of the shock." While investors feverishly price in central banks' hawkish expectations, they are systematically and severely underestimating "left-tail risk"—the risk that high energy costs will ultimately cause a collapse in total demand and a dramatic slowdown in economic growth.

Goldman Sachs has deliberately added "For Now" to the report title.

Its core assessment: inflation domination is only a temporary frenzy, and concerns over economic growth will ultimately take over the market, stabilizing forward rates and flattening the yield curve. But until the situation cools or there are clear signs of deterioration in the labor market, investors need to remain highly cautious with arbitrage trades.

Inflation Panic Dominates: Global Central Banks Turn Hawkish, Sharp Shift from Cutting to Raising Rates

Over the past week, "inflation vigilance" has become the common theme among global central banks, with an unusually dense wave of hawkish signals.

The Fed's March FOMC meeting continued the hawkish tone. Goldman points out that inflation risk has become the absolute focus of the rates market. Although growth risks have risen, initial economic fundamentals remain solid and market reactions are orderly, which limits the space for growth concerns to outweigh inflation.

To tilt the balance toward growth, tail risks must first become "sufficiently obvious and persistent"—either the stock market shows a more sustained negative response to rising oil prices, or there are clearer signs of worsening in the labor market.

In an environment of supply shocks, the diversification benefits of nominal bonds themselves are already reduced, meaning the threshold for the market to switch to a growth narrative is higher.

The repricing in Europe is particularly intense.

The report shows that Europe’s short-term rates are currently pricing in nearly three rate hikes, reflecting deep worries about persistently high commodity prices (damaged energy infrastructure may limit inflation relief).

Goldman notes that major central banks like the ECB are showing openness to near-term hikes, rather than staying patient in the face of what may be temporary shocks. Current pricing is already approaching the upper limit of Goldman economists’ risk scenarios.

Given that every increase in energy prices tightens financial conditions and weakens growth outlook, the difficulty for the market to continue "out-hawking" is rising.

The most notable case is the UK.

Following the Bank of England meeting, the 2-year gilt yield rose more in the 20-minute window around the announcement than during any policy meeting in the entire 2021-2024 rate hike cycle.

On this basis, Goldman economists no longer expect the Bank of England to cut rates this year and have significantly raised the forecast for the 10-year gilt yield at the end of 2026 to 4.40% (previously 4.25%), while flattening the 2-year/10-year curve forecast to 50 basis points.

As of March 20, markets were even pricing in nearly 90 basis points of hikes for 2026. Goldman believes this pricing is too high, but acknowledges that a clear downward path for commodities is needed to ease it.

Core Judgment: Terminal Rate Selling "Inconsistent with Nature of Shock," Left-Tail Risk Severely Underestimated

Amid the market being dominated by the inflation narrative, Goldman believes that the continued sell-off in terminal rate pricing is inconsistent with the nature of this shock.

The evidence: neither long-term inflation rates nor long-term risk premiums show the market is worried the Fed’s policy reaction will be "too dovish."

In other words, the market heavily prices rate hikes in short-term rates, but at the long end, there isn’t a reflection of fear that central banks will let inflation run too hot. If the market truly believed inflation would spiral out of control, long-term risk premiums should surge—but they haven’t. This suggests that terminal rate selling reflects panic more than fundamental logic.

More critically, Goldman believes the "left-tail" risk—where damage to total demand starts to outweigh inflation concerns—has been severely underpriced.

The report notes that, although the reset in rate volatility caused by hawkish policy risk is now comparable to the spike during "liberation days," the volatility surface relative to macro fundamentals is no longer cheap. However, the short-end skew has embedded a major shift in policy reaction functions, and this shift has gone too far.

On the strategy side, Goldman suggests fading dollar risk reversal options to counter the recent hawkish repricing, rather than directly selling volatility—because the former offers better protection in scenarios where growth turns downward.

Meanwhile, Goldman maintains a cautious stance on carry strategies (including selling volatility and long spreads): though valuations have improved, once the growth "left-tail" opens, such strategies will face severe tests.

Outlook: Growth Concerns Will Eventually Take Over, But the Turning Point Will Take Time

Goldman’s year-end forecasts for major market 10-year yields are generally below current levels and forward pricing, reflecting its medium-term view that "inflation dominance will eventually give way to growth concerns."

Specifically: US 10-year Treasury yield year-end forecast at 4.10% (currently about 4.37%, 43bps below forwards); UK Gilt 4.40% (75bps below forwards); Japan JGB 2.00% (currently 2.28%); German Bund 3.00% (currently 3.04%).

Goldman’s position and sentiment monitoring also shows that US option implied position indicator (OPI), fund position indicator (FPI), and data reaction indicator (DRI) are all currently near zero—there is no obvious market bias between bulls and bears.

This neutral state itself means that once the macro narrative switches, there is ample room for the market to move sharply in either direction.

Goldman’s advice is clear: keep directional exposures light and participate with limited risk. Until geopolitical events or economic data provide clear trigger signals, inflation fears in the bond market may persist for some time—but the contradiction between terminal rate pricing and the nature of supply shocks ensures this state cannot last forever.

Once evidence of growth deterioration accumulates sufficiently, reverse corrections in the rates market could come swiftly and violently.

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