Citi warns bond volatility poses risk to equities

Citi cautioned on Friday that equity markets face heightened danger as bond volatility surges, a trend the bank attributes to the long end of the yield curve rather than shifting Federal Reserve expectations. The bank's analysis indicates that risky assets are currently more sensitive to the turbulence of a rates sell-off than to the absolute level of interest rates, a dynamic tracked by the MOVE index.

The MOVE index exceeded two standard deviations on a one-year basis last Thursday. This spike followed strong PMI data and a weak auction that drove the 10-year Treasury yield above 5%. Citi noted that historically, such elevated readings in the MOVE index have aligned with declines in the S&P 500.

While the bank suggested some stability may return, it emphasized that the current environment differs from previous episodes. Typically, the MOVE index retreats below this threshold within days, and volatility subsides once investors clarify the Fed's hiking pace, a process that often spans two months following the first rate increase. However, Citi argued that this historical pattern does not apply here because monetary policy is not the primary driver of the recent moves.

Instead, the bank's strategists identified a buyer's strike as the cause of the strain on the back end of the curve, making recent auction weeks significantly worse than usual. Citi believes the neutral rate is rising in tandem with a strong growth outlook. With no immediate catalyst to end the buyer's strike, the bank suggests the MOVE index may remain high. Additionally, while the S&P 500 has remained steady, Citi observed that small-cap stocks have experienced a sharper decline.