Citibank provided insights on the European Central Bank's (ECB) potential monetary policy trajectory, suggesting that the risks are tilted towards a more prolonged cycle of interest rate cuts. Contrary to current market expectations, which anticipate a 50 basis point reduction in January or March and an end to the cutting cycle by mid-year, Citibank posits that a steadier cycle of 25 basis point increments may be more likely.
Citibank's analysis points to the mid-year period when markets expect the ECB to pause, which coincides with the anticipated maximum impact from Trump-era tariffs. In this context, Citibank predicts that dovish policymakers may favor a lower terminal rate over a quicker pace of rate reductions. Conversely, if hawkish voices prompt a pause, the rate-cutting cycle could resume later in response to persistent weak growth, encouraging investment.
In terms of bond markets, Citibank's base case is mildly bullish on German Bunds compared to forwards and consensus. The bank targets a yield trough of around 1.85% for 10-year Bunds by mid-year, followed by a rise to 1.95% in the fourth quarter of 2025. Citibank sees favorable risk-reward in certain futures positions and suggests tactical long positions in 5-year inflation-linked swaps.
Regarding the € curve, Citibank's terminal rate estimate remains 20 basis points more dovish than market consensus after November's rally. The bank does not find the risk-reward in 2-year to 5-year curve steepeners appealing and suggests a strategy that would benefit from an out-steepening of the 10-year to 30-year segment versus the 5-year to 10-year segment, given a resilient macroeconomic environment.
For European government bonds (EGBs), Citibank forecasts a spread of 60-70 basis points between 10-year French OATs and German Bunds in a bullish scenario, widening to 130-140 basis points in a bearish scenario. The bank maintains a structural long position on Spanish bonds versus French OATs and Belgian OLOs, and a tactical bearish stance on Italian BTPs. Citibank also favors a flattening position on the Spanish 10-year to 30-year curve versus French or Belgian bonds.
In the UK, Citibank anticipates the possibility of accelerated Bank of England (BoE) rate cuts later in 2025, setting a target yield of 3.35% for 10-year gilts by year-end. The bank recommends long positions in 10-year gilts versus French OATs, maintaining short positions in 10-year gilt asset swap spreads, and is monitoring short positions in 5-year inflation-linked swaps.
Finally, Citibank takes a slightly bearish stance on € SSA and covered bond swap spreads going into 2025 due to high net cash requirements (NCRs), but expects performance improvements in the first quarter of 2025. The bank advises buying 5-year KFW bonds versus Bunds and selling positions in 2.5-year versus 4.5-year CADES. Citibank forecasts a supply of €1278 billion in EGBs for 2025, resulting in an annual NCR (NYSE:VYX) of +€637 billion.
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