Citigroup Advises Bets on U.S. Treasury Underperformance, Dollar Decline Amid Fed Independence Concerns

Citigroup strategists have advised investors to increase their bets on the underperformance of long-term U.S. Treasuries and a decline in the U.S. dollar, citing concerns over the independence of the Federal Reserve. The strategists, including Adam Pickett and Dirk Willer, suggested that investors should add a small portion to their existing positions to bet on the underperformance of 30-year U.S. Treasuries relative to 5-year U.S. Treasuries, as the yield curve is expected to steepen. They also recommended going long on the euro against the U.S. dollar through derivatives.

This recommendation comes as the U.S. President has been exerting pressure on the Federal Reserve, raising concerns about the central bank's political independence. The strategists had initiated this "steepening trade" in May, anticipating that the President's tax cuts would lead to increased government debt and pressure on long-term bonds. The trade has gained popularity in recent months, especially after the Federal Reserve Chairman hinted at potential rate cuts to support the labor market, which could benefit short-term Treasuries while pushing up long-term yields due to inflation and fiscal risks.

The U.S. President's recent dismissal of a Federal Reserve Board member, citing alleged mortgage fraud, has further fueled concerns about the central bank's ability to control inflation and maintain its independence. This move has led to speculation that the President may appoint a more dovish policymaker, which could lower short-term rates but also raise long-term inflation expectations. The yield spread between 30-year and 5-year Treasuries widened to its highest level since 2001 following this development.

Jonathan Cohn, the head of U.S. rates strategy at Nomura Securities International, noted that the steepening trade remains attractive to investors due to the asymmetric downside risk in policy rates and the potential impact on the long end of the curve if the Federal Reserve's credibility is questioned. Citigroup strategists also expressed surprise that the U.S. dollar has not depreciated more significantly amid the risks to the Federal Reserve's decision-making body. They attributed the dollar's resilience to renewed fiscal concerns in France but believed this would not substantially weaken market demand for the euro.