“While the near-term picture is murky, our conviction on the broader macro picture is supportive of higher rates in the 10-year” Treasury note, writes Citigroup Inc.’s Jabaz Mathai in a client note. However, “on the macro side, continued worries about a sharp China/EM slowdown can pull rates lower.”
The strategists devised a new package to reduce the cost of bearish Treasury bets: First, buy options that pay off if 10-year yields rise; Second, sell contracts that benefit if the yuan rallies against the dollar. A material China slowdown would be unlikely to drive yuan gains, leaving the options sold to expire worthless. Citigroup assumes slower global growth would continue to equate to a stronger dollar.
Citigroup’s call comes at a potentially pivotal time for Treasuries. Federal Reserve Chairman Jerome Powell is due to address the annual Jackson Hole symposium with investors eager for clues on when the central bank will start reducing stimulus and how policy makers plan to navigate an environment of elevated inflation and a resurgent pandemic. Citigroup notes the outlook for Treasuries over the next couple of weeks is hard to call, but they maintain a forecast for benchmark yields at 2% by the end of the year, expecting that the Fed will remain on track to start tapering bond purchases this year.
The People’s Bank of China lowered the reserve requirement ratio for the first time in over a year in July, in a bid to support economic growth. The PBOC has said the RRR cut didn’t signal a shift into broader easing, but markets have started pricing in lower rates. Since then, a short-lived spate of domestic Covid-19 cases further complicated the outlook. Over this period, however, the U.S. dollar-yuan rate has been broadly steady.
The Weekly Fix: How China Bonds Became the New JGBs
Citigroup recommend re-initiating short positions in Treasuries through buying a structure known as payer spreads on 10-year swap rates, with a 6-month expiry, aiming for rates to rise by 25 to 50 basis points. They simultaneously, suggest selling 3-month puts on USD/CNH struck at 6.40.
– Bloomberg