GOLDMAN SACHS: THE TREASURY BULL RUN IS OVER

By Min Zeng

• Goldman’s Garzarelli says yields will rise as the U.S. economy picks up speed in the second half
• Garzarelli expects Treasurys to post 5% losses in the second half
• Garzarelli recommends short positions on five-year notes

This week’s heavy selloff in U.S. Treasurys has prompted Goldman Sachs, one of the biggest Treasury bond dealers, to declare that the months-long bull run is dead.

“We think the rally is over,” Francesco Garzarelli, chief interest-rate strategist in London at Goldman Sachs Group Inc., said in an email interview with Dow Jones Newswires on Thursday. Goldman has long held to the view that Treasury prices would fall over the course of this year.

This past week, the Treasury market has sold off in each trading session. The benchmark 10-year note’s yield, which moves inversely to its price, has surged more than 30 basis points to 3.151% Thursday from a six-month low of 2.842% on Monday.

The main triggers for the end to a rally that started in early April were associated with events that reduced the risk of default by Greece, including the crucial passage of necessary austerity measures by the country’s parliament. This prompted investors to rotate out of safe-haven Treasurys and into stocks.

Some stronger U.S. data, such as Thursday’s business outlook index for the Chicago region, added to these trends by boosting the view that the U.S. economy could pick up speed in the coming months, after a soft patch in the first half.

Garzarelli said Treasury yields will rise as he expects the economic numbers to improve in the third and fourth quarters, while U.S. inflation excluding food and energy–a measure closely watched by the Federal Reserve that has been ticking up in recent months–will hold to its higher levels.

Garzarelli said Goldman Sachs expects the U.S. economy to grow at an annualized rate of 2% in the second quarter and accelerate to 3.25% in both the third and fourth quarters of 2011.

In a monthly report, Garzarelli predicted the total returns on U.S Treasurys at negative-5% for the second half, while German bunds–another safe-haven asset–would post a loss of 3%.

Even as Treasurys rallied and yields fell in prior months, Goldman stuck to its forecast for the U.S. 10-year yield to rise to 3.75% by the end of the year while other major dealers reduced their end-2011 yield projections.

Garzarelli recommended clients short the five-year Treasury note in expectation that it will decline in price. That note has been one of the best performing maturities in the Treasury market in recent weeks.

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