Citibank Warns of U.S. Fiscal Crisis, Predicts 50% Chance of Market Downturn

Citibank has highlighted a potential shift in the narrative surrounding U.S. assets, moving from tariff issues to fiscal crises. As the DOGE's spending cuts decrease and tariff revenues decline, the U.S. fiscal budget process could trigger a surge in the term premium. This could lead to a "three kill" scenario, where U.S. stocks fall, U.S. bond yields rise, and the U.S. dollar weakens.

Despite recent market rallies and a strong dollar, Citibank believes the current dollar strength is only temporary. The bank predicts that the U.S. stock, bond, and currency markets still face a "down kill" probability for the rest of the year. The report emphasizes that as DOGE's spending cuts decrease and tariff revenues decline, the term premium could surge again, leading to a decline in U.S. stocks, an increase in U.S. bond yields, and a weakening of the U.S. dollar.

Citibank's analysis points to two main risks for the summer: an expanding budget deficit that could cause the term premium to surge again, and weakening economic data, particularly in the labor market, which is expected to be at its seasonal low. The bank anticipates that the May labor market report could show the negative impacts of recent policies, potentially leading to increased expectations of a rate cut by the Federal Reserve, from the current 50 basis points to the previous 100 basis points.

Citibank suggests that investors should understand the connection between the policies of the Trump administration. The DOGE plan aimed to reduce costs, while tariffs were intended to increase revenue. These policies were meant to work together to implement larger tax cuts without significantly increasing the fiscal deficit. However, the chaotic implementation of these policies has led to a rapid reversal, which, while beneficial for risk assets, also indicates that the final version of the Trump tax law could result in a larger fiscal deficit than expected.

Citibank's rate strategy team uses the 30-year swap spread as an indicator of term premium risk, predicting that the spread will narrow further to -95 basis points later this year. Historical data suggests that periods of high term premium can persist, and with the budget issue becoming a focus, this situation could recur. Additionally, foreign investor demand for U.S. bonds remains low, further exacerbating fiscal risks.

Citibank advises that the current dollar rally presents an opportunity to sell the dollar at a better price this year. The bank maintains that the dollar's weakness this year is cyclical rather than structural. Analysts note that in an environment of falling stocks and rising yields, the dollar has performed poorly recently. Combined with the potential for increased expectations of a rate cut by the Federal Reserve, this could pose a double blow to the dollar, potentially driving the euro/dollar towards the 1.20 level later this year.

Analysts are particularly focused on the attractiveness of long positions in the Swiss franc as a safe haven. However, they note that the Swiss National Bank cannot intervene in the pharmaceutical industry's tariff issues, as this could be seen as currency manipulation. The recent rally in the dollar/swiss franc pair makes the risk/reward ratio for shorting attractive. Citibank emphasizes that as the market narrative shifts from tariff issues to fiscal risks, investors should closely monitor whether the 30-year U.S. bond yield breaks the 5% threshold and whether the yield curve steepens, as these could be signals of increasing term premium risk. This would allow for advance preparation for potential adjustments in risk assets and dollar weakness.