Goldman Sachs: Treasury Yields Will Hit 4%

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Bond exodus accelerates as yields creep nearer 3%
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A rise in 10-year Treasury yields above 2.7 percent on Friday for the first time since August 2011 is just the start of a long-term upward trend, Goldman Sachs said, with the investment bank forecasting yields will now enter 2014 at 2.75 - 3 percent and will climb to 4 percent by 2016.

Yields moved to a near 3-year high following better-than-expected payrolls number on Friday on expectations that the positive data will prompt the Federal Reserve to start scaling back bond purchases.

"Factors driving yields higher include the improving outlook for growth in the U.S. (and partly also in Europe), a decline in systemic risks stemming from the euro area, and the reduction in the pace of Fed purchases," Francesco Garzarelli, head of market research for Europe at Goldman Sachs said in a research note on Sunday.

(Read More: Bond Yields Getting Closer to Pain Threshold )

"In this regard, our U.S. Economics team now calls for the Fed to announce its intention to taper its monthly purchases of Treasuries and Agency MBS (mortgage backed securities) in September.

This follows Goldman Sachs' bearish call on Treasurys at the end of May when rates began to rise off record lows. "The bond sell-off: It's for real," the bank's fixed income team said at the time.

The bond rout began on May 22, after the minutes of the Fed's policy meeting signaled that its bond-buying program-which has suppressed yields and boosted stocks-could soon be pared back. Fed Chairman Ben Bernanke echoed these comments at a press meeting in June, suggesting that asset purchases could be scaled back later this year, if economic data continued to show improvement.

And that data has been improving. The U.S. economy created 195,000 new non-farm payroll jobs in June, the Labor Department reported on Friday, better than estimates of 165,000 with the unemployment rate staying unchanged at 7.6 percent.

(Read More: Goldman: This US Treasury Sell-Off Is for Real )

Stocks were initially indecisive, trading in the negative before rising 1 percent towards the close . The dollar jumped to a three-year high and gold tumbled 3 percent. The 10-year Treasury yield pushed above 2.725 percent to its highest since August 2011 and settled at 2.693 percent on Monday morning.

Analysts have cited concerns that a rise in bond yields would cause capital losses for pension and insurance funds as bond prices fall lower. Fears over a derailing of the housing recovery have also been touted, since yields on benchmark Treasurys affect the interest rates on fixed-rate mortgages.

"Bond market carnage poses significant risks to economy and corporate America," TrimTabs CEO David Santschi said in a research note on Sunday.

Artificially low mortgage rates and private equity investors taking advantage of investors' thirst for yield have been key underpinnings of the housing rebound, the research firm said. The backup in rates is therefore likely to put a damper on housing demand, it said.

(Read More: 'Unprecedented' $80 Billion Pulled From Bond Funds )

"While Wall Street regularly reminds us that U.S. companies hold records amounts of cash, these companies also owe record amounts of debt. The action in the bond market is something equity investors need to watch carefully," Santschi said.

But not everyone believes yields will continue on their course upwards. Bill Gross, the manager of Pimco's flagship Total Return Bond Fund - which has seen outflows of $9.6 billion in June according to Morningstar - said in his July newsletter that investors shouldn't jump ship yet.

He said that yields should actually be trading at 2.2 percent. Judging from the tweet he posted over the weekend, that view hasn't changed.

Gross: 1 to 2 month performance numbers are a blip on a 40-year performance history. PIMCO marches on a long-term path.

-By CNBC.com's Matt Clinch. Follow him on Twitter @mattclinch81.



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