Goldman Sachs: Cooling inflation brings a breather, but global rate curves still favor selective longs in the belly and steepeners

Overview

This is a Goldman Sachs Global Rates Trader strategy report titled “Quick Duration Break.” The report argues that cooler US inflation in June has provided a brief breather for rates markets, but Fed officials remain focused on the inflation mandate, and more benign inflation data will be needed to further price out hike risks. Globally, front-end hawkish risks in Europe and the UK have already been priced fairly fully, but upside risks in energy prices, especially European natural gas, may limit near-term easing. The report’s broad curve view is that front-end rates are likely to ease and yield curves to steepen by end-2026, while long-end yields remain relatively sticky due to fiscal factors, supply, term premium, and investment demand.

Core views

The core views include: First, US rates longs should favor the 5-year sector rather than the long end, because 2s5s still has room to flatten when inflation rises, while long-end forwards may remain stickier in a rates rally. Second, although long-dated US inflation swaps are somewhat cheap relative to fundamentals, economists expect inflation over the next 12 to 18 months to run below market pricing, and any inflation upside may be absorbed through higher real rates, so they do not currently present an attractive outright long. Third, overall demand for US Treasuries remains healthy, but the absorption of second-half bill and coupon net supply, crowding out of stripping demand from long-end corporate supply, a slowdown in overseas official buying, and the pace of bank buying all need to be monitored. Fourth, the Canadian curve is likely to steepen on expectations of policy normalization, and the belly of the CAD curve may have some room to underperform the US. Fifth, front-end hawkish pricing in Europe and the UK is already full, so the next move is more likely to be front-end easing and curve steepening, but energy and fiscal risks will keep long-end term premium sticky.

Analysis framework

The report uses a macro rates strategy framework, combining inflation data, central bank communication, energy prices, government bond supply and demand, money markets, investor positioning, asset swap valuations, curve carry/rolldown, and G10 yield forecasts to form cross-market views on duration, curve, and relative value. The US section focuses on the Fed reaction function, core PCE, bill supply, repo rates, TGA, money market fund AUM, and the Treasury buyer base; the Europe and UK sections focus on natural gas prices, central bank meeting pricing, the impact of inflation surprises on the curve belly, and support for EGB asset swaps from looser leverage regulation; the Japan section distinguishes between the modest support from flows for JGB allocations and the dominant role of macro conditions in driving yields.

Methodology notes

• macro_ratesFed reaction function and inflation path analysis

  Use inflation data, the labor market, and central bank communication to judge whether hike risks can continue to be priced out.

  The report notes that a stable labor market keeps the Fed focused on inflation, and June’s inflation cooling is only a breather; with core PCE still above 3% year over year, further compression of hike pricing requires more benign inflation data.

• relative_valueMacro valuation framework

  Use fundamental variables to assess whether inflation forwards and rate forwards are rich or cheap.

  The report says long-dated inflation forwards are slightly cheap relative to fundamentals, but 1y1y and 2y2y are firm due to oil prices, and baseline inflation forecasts are below market pricing, so it does not recommend outright inflation longs at present.

• supply_demandTreasury supply-demand and flow monitoring

  Analyze bills, coupon supply, Fed purchases, money funds, overseas buying, banks, and dealer absorption capacity.

  The report expects net US bill supply in 2H26 to be $684 billion and net coupon supply to be $605 billion, and believes absorption can still be supported by the Fed, money funds, the overseas private sector, and bank intermediation capacity, though long-end corporate supply and slower official buying warrant attention.

• curve_strategyCurve steepening and carry/rolldown framework

  Combine central bank pricing, term premium, and curve carry to select 2s10s, 2s5s, and cross-market curve trades.

  The report maintains trade recommendations such as GBP 2s10s steepeners and CAD 2s10s steepeners, and believes that front-end hawkish risks in Europe and the UK are already fairly fully priced, so if inflation eases, the front end and belly should benefit more from a rally.

Asset mapping & comparison

Structured mapping from thesis to named assets (strengths, weaknesses, peers, risks).

• US Treasuries / USD rates

  core covered asset

  Strengths

  Cooling inflation provides a short-term breather, overall Treasury demand is still viewed as healthy, and the Fed and money funds are likely to absorb some bill supply.

  Weaknesses

  Core PCE remains above 3% year over year, long-end yields may lag in a rally, and absorption of 2H26 bill and coupon supply still needs to be validated.

  Comparison

  Compared with the long end, Goldman prefers to anchor US duration longs in the 5-year sector; compared with long-dated inflation forwards, belly duration in the nominal rates curve is more attractive.

  Risks

  Rising energy prices, hawkish Fed communication, inflation data surprising to the upside again, weak long-end supply absorption, and repo funding pressure.

• USD traded inflation

  relative value monitoring target

  Strengths

  Long-dated inflation forwards are slightly cheap relative to the macro valuation framework.

  Weaknesses

  1y1y and 2y2y are strong due to oil prices, and baseline inflation expectations for the next 12 to 18 months are below market pricing.

  Comparison

  Long-dated forwards are cheaper than short-end inflation forwards, but the report still does not think that is enough to support an attractive outright long.

  Risks

  Further oil price upside, higher real rates if the Fed does not turn dovish, and greater risk-asset volatility.

• CAD rates / USD-CAD 5y spread

  cross-market relative value

  Strengths

  BoC policy is at the bottom of the neutral range, and a recovery in activity plus AI buildout-related tailwinds support normalization in the Canadian outlook.

  Weaknesses

  Trade risks have eased but may re-emerge, and the belly of the CAD curve may underperform the US.

  Comparison

  The report argues that the USD-CAD 5-year spread is at a wide level excluding last year’s trade war period, while the growth outlook differential has narrowed, leaving room for the spread to tighten.

  Risks

  A renewed slowdown in Canadian growth, rising trade shocks, an unexpectedly dovish BoC, or relative upside in US belly rates.

• EUR rates / EGB asset swaps

  European rates and sovereign bond strategy

  Strengths

  Front-end hawkish risks in Europe are already fairly fully priced, and potential leverage-ratio easing could provide modest support to EGB asset swaps.

  Weaknesses

  Rising natural gas and energy prices may still weigh on short-term performance, and higher rate volatility is a headwind for sovereign carry.

  Comparison

  The report believes 1y1y still looks high relative to forecasts, but it is not obviously misaligned relative to 1y1y HICP; it is more constructive on subsequent curve steepening and the positive risk-reward of EGB asset swaps.

  Risks

  Further rises in natural gas prices, soft signals from the ECB pointing to a September hike, and a smaller-than-expected improvement in European banks’ capacity to absorb government bonds.

• GBP rates / Gilts

  UK curve strategy

  Strengths

  Ahead of the BoE meeting, hawkish risk is already fairly fully priced in the front end, and if inflation comes in soft, there is room for a rebound in the front end and belly.

  Weaknesses

  Fiscal uncertainty, autumn budget risk, and sticky term premium limit sustained outperformance of the long end.

  Comparison

  Rather than simply buying long-end Gilts, the report continues to recommend a GBP 2s10s steepener because the BoE may be more dovish than market pricing implies, while fiscal risks weigh on the long end.

  Risks

  A sharp upside surprise in UK CPI, rising energy prices, fiscal policy uncertainty after the leadership transition, and increased autumn budget risk.

• JGBs

  Japan rates and flow monitoring

  Strengths

  GPIF and NISA are driving savings toward domestic assets, which may increase JGB allocations by pension and retail segments and provide modest support to long-end spreads.

  Weaknesses

  The report argues that flows are not the dominant driver of JGB yields, and macro conditions still matter more.

  Comparison

  Compared with curve trades in the US, Europe, and the UK, the JGB view is more of a supplementary flow observation rather than a core trade recommendation.

  Risks

  Changes in Japan’s macro conditions, shifts in inflation and central bank policy paths, and renewed domestic outflows into foreign assets.

Key data

• Expected monthly US core PCE for June18bpGoldman Sachs economists’ expectation for June core PCE after that week’s inflation data.
• US core PCE year over yearabove 3%Used in the report to show that inflation remains materially above target and the Fed cannot quickly turn dovish.
• Net US bill supply in 2H26$684 billionGoldman Sachs’ baseline forecast for US bill supply in 2H26.
• Net US coupon supply in 2H26$605 billionGoldman expects this supply to be absorbed by a range of buyers including the Fed, money funds, the overseas private sector, and banks.
• Additional Fed bill purchases within the year$130 billion to $140 billionThe report expects the Fed to purchase additional bills through year-end to support bill supply absorption.
• Repricing in European 1y1y since the July 2 lowmore than 30bpReflects renewed front-end pricing driven by upside risks in European energy and natural gas.
• Potential balance-sheet capacity from looser European bank leverage rules€180 billionEstimated by Goldman’s bank team as potential incremental capacity; assuming around 5% is allocated to government bonds, that implies about €9 billion of direct bond holdings.
• Historical threshold for large rate volatility triggered by UK CPI surprisesabout 20bp or moreThe report says that when UK CPI deviates by more than 20bp, it has historically been more likely to trigger rate volatility of more than one daily standard deviation, with the 5-year sector reacting the most.
• USD 10-year yield forecastSpot 4.53%; 3Q26 4.45%; 4Q26 4.40%; 1Q28 4.25%From the G10 10-year yield forecast table.
• GBP 10-year yield forecastSpot 4.93%; 3Q26 4.60%; 4Q26 4.50%; 1Q28 4.30%From the G10 10-year yield forecast table.

Impact & implications

The portfolio implication is that global rates markets are not simply entering a broad duration-long environment. Cooling US inflation helps ease risk, but long-end yields are constrained by cyclical resilience, AI investment, term premium, and supply absorption, making duration longs more suitable around the 5-year sector; in Europe and the UK, although near-term hawkish risks are already fully reflected, energy upside and fiscal uncertainty will restrain long-end performance, so curve steepeners fit the report’s logic better than simply betting on long-end yields falling; in Canada, policy remains at the bottom of the neutral range and the economy is normalizing, which supports relative underperformance in the belly of the curve versus the US and a narrower USD-CAD 5-year spread.

Risks

• US inflation data strengthens again, causing the Fed to maintain or reinforce a hawkish stance.
• Rising energy and natural gas prices push up front-end hike pricing in Europe and the UK.
• US 2H26 bill and coupon supply absorption falls short of expectations, leading to greater pressure in the long end or money markets.
• UK fiscal uncertainty and autumn budget risk keep term premium sticky.
• Increased long-end corporate bond supply weakens US Treasury stripping demand and support for long-end valuations.
• If declining overseas official buying shifts from being driven by dollar strength to a structural change in demand, it would weaken the constructive US Treasury demand view.
• Communication from the BoC, ECB, or BoE diverges from market expectations, affecting performance of curve steepener trades.

What to watch

• Whether subsequent US core PCE and CPI continue to come in benignly.
• How Fed officials describe the tradeoff between inflation and the labor market before and after policy meetings.
• The data-heavy period ahead of the September FOMC and changes in hike pricing.
• US bill issuance, TGA rebuilding, money fund AUM and WAM, and the position of repo rates relative to IORB.
• Changes in US long-end corporate issuance and UST stripping activity.
• Whether the BoC continues to describe policy as “appropriate” and the pace of Canada’s activity recovery.
• European natural gas prices, the ECB meeting, and changes in the 1y1y-2y2y curve.
• UK CPI surprises, BoE MPC pricing, the political transition, and fiscal risks related to the autumn budget.
• Changes in JGB allocations by Japan’s GPIF, NISA, pension, and retail investors.