Citigroup Says Treasury Selloff Signals Bearish New Era for RiskBy
Slew of theories but bank sees post-QE normalization at work
‘Much more protracted’ repricing seen, unlike any since crisis
For global markets, it’s back to life, back to reality.
As the Treasury selloff kicks off in earnest, Citigroup Inc. says investors should prepare for a possible “normalization’’ of risk premiums across credit and emerging markets as the era of monetary distortion unravels.
A bearish breakout in the world’s largest bond market remains an underestimated risk, strategists Mark Schofield and Ben Nabarro wrote in a Monday note. They caution a “structural re-pricing of asset markets” -- the like of which hasn’t been seen since the financial crisis -- could be brewing.
“Recent dialogue suggests that investors are much more attuned to the scenario in which rising yields and a strong dollar choke off the recovery, bringing yields back down, than they are to a scenario in which we see rates back to pre-crisis levels,” the pair wrote.
Their bearish comments follow a retreat across global debt markets last week that drove the yield on 10-year U.S. notes firmly above its 3.05 percent resistance level. Investor sentiment remains sanguine, according to the strategists, with bulls arguing Treasury headwinds have been exacerbated by transitory forces like oil and stretched positioning. And the healthy business cycle is seen offsetting a more-restrictive monetary climate, keeping risk premiums low.
Yet that may be wishful thinking.
The retreat in U.S. debt has been driven by real yields rather than market-derived headline inflation expectations, suggesting an uptick in oil prices isn’t the main culprit behind the selloff, according to Citi.
The U.S. economy’s upward march in concert with a term premium -- the extra compensation to hold longer-maturity Treasuries over short-term securities -- would justify the 10-year benchmark at 4 percent to 4.5 percent, according to Citi.
The strategists don’t necessarily see bond yields heading to such giddy heights. And even if they did, by slamming the brakes on two key drivers of global growth -- emerging markets and U.S. expansion -- it could create a “self-stabilizing” mechanism that cushions the impact on risk premia by spurring a rally in U.S. bonds.
It all adds up to a complicated picture for investors, but for Schofield and Nabarro that’s not enough to justify why the various Treasury breakout scenarios are priced so “asymmetrically.” That is, why traders judge that Treasury yields are more likely to tumble than continue their upward march.
Benchmark yields of up to 4.5 percent are “not the base case view of our strategy teams,” they wrote. “It is just a hypothetical scenario. However it is one that is plausible, and one that” the market possibly underestimates as a risk, according to the note.
— With assistance by Cormac Mullen