Citi Warns Bond Volatility Has Entered 'Dangerous Phase' for Stocks

A recent spike in bond market volatility has entered a "more dangerous phase" for risky assets, as the driver shifts away from Federal Reserve policy expectations toward a selloff at the long end of the Treasury curve, according to analysts at Citi.

In a note published Friday, the bank highlighted that the latest surge in volatility is more concerning because it is not being driven by a repricing of the Fed's expected rate path.

A Shift in Volatility Drivers

Citi's analysis focuses on the MOVE index, a key gauge of U.S. Treasury market volatility. The bank stated that many risk assets are driven less by the absolute level of interest rates and more by the volatility of a rates sell-off, as measured by the MOVE index.

Last week, the index broke above two standard deviations on a one-year lookback. This followed a period of pressure on long-dated government bonds, which saw the 10-year Treasury yield push above 5% following strong PMI data and a weak debt auction.

Historical Precedent and Current Concerns

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While the MOVE index has historically fallen back below this threshold within days, Citi cautioned that this historical comfort relies on monetary policy being the primary driver. Volatility typically calms once investors understand the Federal Reserve's hiking cycle, usually about two months after the first increase.

However, the bank's strategists believe the recent move is different. They point to a potential "buyer’s strike" at the long end of the curve, which has made Treasury auction weeks "notably worse than normal." This suggests the current volatility stems from a structural shift in demand for U.S. debt rather than short-term policy speculation.

Market Impact and Outlook

Historically, elevated readings on the MOVE index have coincided with weakness in the S&P 500. Citi noted that while the benchmark index has remained relatively steady, small-cap stocks have already sold off more sharply amid the bond market turmoil.

Citi’s best guess for the underlying cause is that the neutral rate of interest is moving higher alongside a strong economic growth outlook. With no clear short-term catalyst to break the buyer's strike, the bank suggested that the MOVE index could remain elevated, posing a continued threat to risk assets.