Poor Goldman just can't get anything right these days. Having started off 2016 with euphoric optimism, predicting a soaring dollar and at least 4 rate cuts not to mention a blistering recovery, following a series of hits to the US economy and culminating with the Brexit vote, which as we reported over the weekend prompted Goldman to slash its 2017 UK GDP outlook and to now anticipate a "moderate recession" in the UK in the first half of 2017, and now expects the BoE to announce credit easing policies at its July meeting and to cut interest rates 25bps at its August meeting.

Worse, Goldman has thrown in the towel on its US recovery narrative - again - and has reduced its US forecast by 0.25% in 2016 to 2.0%  "and now expect just one further hike by the Fed in 2016 in December." Putting this in context, the market believes there is a greater possibility of a rate cut than hike in the next two FOMC meetings.

Which naturally means that not only will Goldman soon have to cut its year end S&P forecast if only to prompt the Fed to be more dovish than expected, but will have to cut its year end 10Y forecasts.

Which it did moments ago.

Government bond yields in the major advanced economies moved sharply lower on the back of the largely unexpected news of Brexit. The levels that 10-year rates touched were broadly in line with our previous estimates of what the knee-jerk impact could have been (1.35% on TY10, -10bp on German Bunds, 1.0% on Gilts and BTPs at 1.85-2.00%) although the price action did eventually stabilize. Exhibits 1 and 2 below illustrate movements in 10-year US Treasury and Italian BTP yields since 30 May.

Our empirical analysis, shown in Exhibit 3, suggests that, since the end of May, the largest contribution to the global yields has been the UK Gilts market – which has sent 'bond-bullish' impulses to other major markets. At the margin, US Treasuries are not pushing global rates higher as they had been doing in April and May. German Bunds, by contrast, appear to be mostly responding to external forces rather than fuelling the rally on their own accord. 

Our Economics team has revised their baseline macroeconomic projections, which were built under a 'Remain' assumption. These envisage a 275bp cumulative hit to UK real GDP, prompting a rate cut in August followed by a long period of ultra-low rates and possibly outright purchases of credit instruments; a modest-sized hit to Euro area GDP (50bp below a previous above-trend baseline) and an extension of ECB QE to end 2018; and only one more hike by the Fed this year, with downside risks.

So how does Goldman arrive to this brilliant conclusion, clearly priced in long ago by the market? Why the Sudoku bond model.

Our Sudoku Bond model estimates for the long-run 'fair value' of 10-year government bond yields based on the new forecasts falls by around 20bp in the US, around 10bp in Germany, and 5bp in the UK and Japan. As also can be seen from Exhibit 4, however, the gap between the model output and actual yields remains statistically large, ranging between 2.0 standard deviations in the US and Canada to around 1.5 standard deviations in the UK and Germany.

Let's hope that it is not Goldman's Sudoky model that is running the Fed's central planning computer.

Finally, some last words from Goldman on European bonds, and especially Italian bonds where GS is most cautious: