Citadel Securities drops bearish view on U.S. Treasuries as markets already priced inflation

[Department of Treasury]

Citadel Securities has dropped its bearish stance on U.S. Treasuries, shifting to a neutral view as macro strategist Frank Flight said markets have largely priced in inflation risks from surging oil prices while underestimating the potential damage to global growth.

In a note to clients Monday, Flight explained that the fallout from the Iran war has created conditions where short-term bonds could gain regardless of how the conflict unfolds.

“It increasingly feels as though the tails for inflation upside and growth downside are asymmetrically fat,” he wrote.

The geopolitical turmoil has created a scenario where short-term government debt (BSV [https://seekingalpha.com/symbol/BSV]), (GVF) may rally in multiple outcomes, according to the strategist.

Flight said a prolonged disruption to oil shipping could weigh on stocks (SP500 [https://seekingalpha.com/symbol/SP500]), (COMP:IND [https://seekingalpha.com/symbol/COMP:IND]), (DJI [https://seekingalpha.com/symbol/DJI]) and corporate bonds (IGLB [https://seekingalpha.com/symbol/IGLB]), (PFIG [https://seekingalpha.com/symbol/PFIG]), (IGIB [https://seekingalpha.com/symbol/IGIB]), (IGSB [https://seekingalpha.com/symbol/IGSB]) as investors brace for slower economic growth, which would likely increase demand for shorter-maturity government bonds.

Alternatively, a de-escalation could drive traders to dial back the hawkish interest-rate bets that were piled on since the U.S. launched the war, creating another pathway for yields to fall.

Market expectations for Federal Reserve policy have now shifted to align with Citadel’s longstanding view that interest rates will remain unchanged this year, Flight noted.

Traders currently expect just one quarter-point Fed cut this year, compared with expectations for as many as three two weeks ago, with options markets showing more than a 20% chance of a rate hike by December.

“As a result, we do not see much left to play for in U.S. fixed-income shorts at these valuations,” he wrote.

Oil prices (CL1:COM [https://seekingalpha.com/symbol/CL1:COM]), (CO1:COM [https://seekingalpha.com/symbol/CO1:COM]) are unlikely to hold around $100 a barrel and will either slide toward $70 if tensions ease or jump to $150 if supply disruptions worsen, according to the strategist.

Even in a higher-price scenario, Flight said tighter financial conditions could ultimately reduce the need for central banks to raise interest rates by dampening growth and inflation expectations.

Positioning for a steeper yield curve—or for short-term bonds to outperform longer-maturity ones—offers the “best protection” for investors in various scenarios, he said, as short-term notes would rally if the conflict eases or the curve could bear steepen if inflation accelerates.

* 30-Year U.S. Treasury yield (US30Y [https://seekingalpha.com/symbol/US30Y]) – 4.86%
* 20-Year U.S. Treasury yield (US20Y [https://seekingalpha.com/symbol/US20Y]) – 4.84%
* 10-Year U.S. Treasury yield (US10Y [https://seekingalpha.com/symbol/US10Y]) – 4.22%
* 2-Year U.S. Treasury yield (US2Y [https://seekingalpha.com/symbol/US2Y]) – 3.69%

Investors can follow all other bond ETFs, here [https://seekingalpha.com/etfs-and-funds/etf-tables/bonds].

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