Goldman Shows How a Big Hawkish Rate Shock Would Affect Markets

(Bloomberg) -- How would markets respond to surprise rate hikes from the Federal Reserve? Goldman Sachs Group Inc. has some answers.

Goldman’s analysis takes a hypothetical hawkish funds rate shock of 150 basis points -- in other words, surprise rate increases of 1.5 percentage points. Such a scenario would boost the 10-year U.S. Treasury yield by 45 basis points, cut stock prices by 9 percent and raise the trade-weighted U.S. dollar by 4 percent, Goldman economists led by Daan Struyven wrote in a note Sunday.

“While the funds rate alone is no longer a reliable predictor of financial conditions, we find that monetary policymakers now affect GDP by influencing financial conditions,” the economists said.

The economists advised against an “overly mechanical interpretation” of the study. They cautioned that the analysis is about unexpected shocks, as opposed to anticipated rate hikes, which would be priced into markets and have a much less dramatic effect. They also noted that relationships between the different factors can change over time and aren’t always linear, and that financial conditions are affected by many things other than Fed policy.

Goldman quantified how several factors affect U.S. Treasury yields, as well.

“A 10 basis-point increase in core inflation leads to a 8 basis-point increase in the 10-year yield,” the economists led by Struyven wrote. “On the policy side, we estimate that a 1 percentage point increase in the budget deficit” relative to GDP raises 10-year interest rates by about 20 basis points.

The report also notes that risk of a recession in the U.S. has risen over the course of 2018, according to Goldman’s model. It’s now at 26 percent for a two-year horizon, which is below the unconditional average.

For a three-year horizon, recession risk is now 43 percent, a gain of 7 percentage points that puts it “just above the historical average,” the report said.

©2018 Bloomberg L.P.