Citi Suggests AMB May Postpone Rate Cuts While Expressing Optimism for Bunds

Citibank has suggested that risks are skewed toward a longer-term rate cut cycle, providing insights into the potential monetary policy trajectory of the European Central Bank (ECB). Contrary to current market expectations, which foresee a 50-basis-point cut in January or March and an end to the cutting cycle by mid-year, Citibank posits that a more stable cycle with a 25-basis-point reduction could be more likely.

Citibank’s analysis points to a mid-year timeframe when markets expect the ECB to pause its actions; this period coincides with the anticipated maximum impact of tariffs from the Trump administration. In this context, Citibank anticipates that dovish policymakers may prefer a lower terminal rate over a faster pace of rate cuts. Conversely, if hawkish voices lead to a pause, the rate-cutting cycle may restart later as a response to sustained weak growth, potentially encouraging investment.

In terms of bond markets, Citibank's base scenario is cautiously optimistic regarding German Bunds compared to futures and consensus. The bank targets a yield low point of approximately 1.85% for 10-year Bunds by mid-year, followed by an increase to 1.95% in the fourth quarter of 2025. Citibank sees a favorable risk-return profile in certain futures positions and recommends tactical long positions in 5-year inflation-linked swaps.

As for the euro curve, Citibank's terminal rate forecast remains 20 basis points more dovish than market consensus following the rally in November. The bank finds the risk-return profile for 2-year to 5-year curve steepeners unappealing and suggests a strategy that benefits from a steepening between the 10-year and 30-year segments, considering a resilient macroeconomic environment.

For European government bonds (EGBs), Citibank forecasts a 60-70 basis point spread between 10-year French OATs and German Bunds in an optimistic scenario, while expecting a widening to 130-140 basis points in a pessimistic scenario. The bank maintains its structural long position in Spanish bonds against French OATs and Belgian OLOs while holding a tactical bearish stance against Italian BTPs. Citibank also prefers a flattening position against French or Belgian bonds on the Spanish 10-year to 30-year curve.

In the United Kingdom, Citibank anticipates an acceleration in rate cuts by the Bank of England (BoE) in the latter part of 2025 and sets a target yield of 3.35% for 10-year gilts by year-end. The bank advises long positions in 10-year gilts against French OATs, maintains short positions in 10-year gilt asset swap spreads, and is monitoring short positions in 5-year inflation-linked swaps.

Lastly, Citibank expresses a slightly bearish stance on € SSA and collateralized bond swap spreads due to high net cash requirements (NCRs) as it enters 2025, but expects performance improvements in the first quarter of that year. The bank recommends buying 5-year KFW bonds against Bunds and selling 4.5-year positions against 2.5-year CADES. Citibank forecasts €1.278 trillion in EGB supply for 2025, predicting it will result in an annual NCR of +€637 billion.