Goldman Sachs picks best hedges for a rate-shock scenario

Goldman Sachs has identified bond puts as some of the most effective hedges against a renewed rates shock, as uncertainty around the Federal Reserve's policy path rises under Chairman Kevin Warsh. The bank said last week's hawkish Federal Open Market Committee meeting has increased uncertainty over the outlook for short-term interest rates, even as lower oil prices have eased concerns about an economic downturn. Bond puts increase in value when bond prices fall and interest rates rise, allowing investors to offset losses elsewhere in their portfolios if borrowing costs jump unexpectedly. In a note published Monday, Goldman said investors are increasingly grappling with the risk that rates remain elevated for longer, with markets pricing a wider range of possible policy outcomes. Warsh held the Fed's benchmark rate unchanged at 3.50%-3.75% in his first meeting as chairman, but his communication was interpreted as hawkish by investors, which pushed the dollar to a one-year high. "Uncertainty around future FOMC communication could keep front-end rates volatility elevated," Goldman strategists led by Christian Mueller-Glissmann wrote. While a sharp repricing in rates is not the bank's base case, Goldman said the most attractive hedges in a renewed policy or rates shock scenario are investment-grade bond puts, long-dated payer options in both euros and dollars, and other trades designed to profit if bond prices fall as yields rise. …