Citi: US Rates Still Have Downside Potential by Year-End

Citi maintains its expectation for US Treasury yields to decline by year-end, though the firm acknowledges a lack of clear near-term bullish catalysts. The recent rise in yields is driven not only by inflation concerns but also by robust employment data, which has led the market to price in potential rate hikes. Citi disagrees with this hawkish pricing, arguing that a growth shock could still emerge, prompting the Federal Reserve to maintain a pause through 2026 rather than hike. In this baseline scenario, front-end forward rates should drift lower.

If the 1-year forward 1-year dollar overnight rate falls from roughly 4.1% to the 3% to 3.25% range, the 10-year Treasury yield could drop below 4% by year-end. Short-term yield trajectories will be influenced by oil prices, seasonal summer patterns, term premiums, and potential Federal Reserve communication. Citi believes the labor market remains in a state of low hiring and low layoffs; any subsequent weakening would push front-end real yields lower. From a strategy perspective, Citi favors front-end and belly swap spread value, carry trades, and long-end inflation exposure. The firm recommends shorting 30-year swap spreads as a macro hedge against potential long-end supply pressures.

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