Citigroup Strategists Hedge Against Potential Trump Interference in the Fed

Citigroup strategists are suggesting an increase in bets against long-dated US Treasury bonds and the dollar, fueled by growing concerns about former President Donald Trump's ability to undermine the independence of the Federal Reserve (the Fed). These concerns stem from Trump's past statements and potential future actions, creating uncertainty in financial markets. Strategists, including Adam Pickett and Dirk Willer, wrote in a recent report that investors should add a “small position” to Citigroup’s existing bets. These bets include expectations that 30-year interest rate futures will underperform 5-year notes, widening the spread between them and steepening the yield curve. They also recommended buying euros against the dollar through derivatives.

Potential Impact on the Dollar and Yield Curve

The report indicates that concerns about diminished Fed independence could mainly manifest through two channels: a weaker dollar and a steeper yield curve. A weaker dollar reflects investor worries about potential inflation and a loss of confidence in the US economy. A steeper yield curve suggests expectations for rising inflation and higher long-term interest rates. Citigroup strategists initiated this bet, dubbed a “yield curve steepening trade,” back in May. At that time, they anticipated that Trump’s tax cuts would increase government debt, putting pressure on long-dated Treasuries. However, Trump’s recent moves, including efforts to dismiss Fed board members and potentially exert influence through regional Federal Reserve banks, have added fresh momentum to this trade.

Risks to Fed Credibility

Potential Trump interventions could jeopardize the Fed's credibility in fighting inflation, potentially leading to higher long-dated Treasury yields. This was also warned by Krishna Guha, head of Evercore ISI's global policy and central bank strategy team. Guha stated that Trump could “trigger a bond market tantrum.”

Market Reactions

Following Trump's announcement to dismiss Fed Governor Lisa Cook, the spread between 30-year and 5-year Treasury bonds widened to its highest level since 2001. Cook, however, disputed the decision, arguing that Trump lacks the authority to dismiss her. Adding to Trump’s previous attempts to persuade Fed Chair Jerome Powell to cut interest rates, this unprecedented move to dismiss a board member has further heightened market concerns that the Fed might be forced to lower interest rates due to political pressure, potentially increasing future inflation risks.

Dollar Resilience

Citigroup strategists expressed surprise that the dollar has not weakened more significantly, even in the face of the Fed’s decision-making body facing a “restructuring risk”. They believe the dollar's resilience may stem from renewed fiscal concerns in France, but this change is “unlikely to significantly weaken market demand for the euro.”

Important Note

This analysis offers a strategic perspective based on specific economic and political forecasts and developments. Investors should conduct their own research and consult a financial advisor before making any investment decisions. Understanding the potential consequences of political events on economic policy is crucial for informed investment strategies.