Citigroup Says to Boost Bets Against Long Bonds on Risks to Fed

(Bloomberg) — Citigroup Inc.’s strategists recommended adding to bets that longer-term US bonds will underperform and the dollar will decline due to the risk that President Donald Trump will undermine the Federal Reserve’s political independence.

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Investors should add “a small position” in Citigroup’s existing wager that 30-year interest-rate forwards will trail five-year tenors, steepening the yield curve as the gap between the two widens, strategists including Adam Pickett and Dirk Willer, wrote in a note Wednesday. They also recommend buying the euro against the dollar via derivatives.

“Fears of a weakening of the Fed’s independence has two main market release valves in our view: weaker USD and steeper curve,” the strategists wrote in a note.

The strategists initiated the trade — known as curve steepener – in May on anticipation that Trump’s tax-cut law would swell the government’s debt, putting pressure on longer-maturity Treasuries.

Trump’s push to oust a Fed governor — and potentially exert influence through regional bank branches — is giving added impetus to the trade by raising the risk that his intervention will prop up on longer-term yields by jeopardizing the central bank’s inflation-fighting credibility.

On Wednesday, the yield gap between 30- and five-year Treasuries widened to the most since 2001 after Trump said he was firing Governor Lisa Cook, who is challenging it on the grounds that he lacks the authority to do so. The unprecedented move by the president, who has attempted to cajole Chair Jerome Powell into lowering interest rates, ramped up worries that the bank will face pressure to lower interest rates for political reasons, fueling future inflation risks.

Citigroup’s strategists said they were surprised that the dollar didn’t weaken even more on the “reconfiguration risks” to the Fed’s decision-making body.

The resilience was probably due to the renewed fiscal concerns in France, a development the strategists says is unlikely to “materially undermine appetite for the euro.”

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