Will FOMC week deliver a rally?

According to analysts at Citi in a note Monday, the last seven FOMC meeting weeks have been bullish for both bonds and stocks.

The investment bank says that this historical trend sets an optimistic tone as the upcoming FOMC meeting approaches on Wednesday, 31 July. Citi analysts predict, "a rally in Treasuries at least into Wednesday, 31 July (FOMC day) close is likely."

However, they believe the sustainability of this rally beyond the FOMC day will depend heavily on weaker-than-expected economic data.

In the short-end of the market, balance sheet constraints are expected to persist throughout the summer and into the year-end. The key factor affecting spreads will be repo and repo expectations, especially concerning year-end stress and the repo market's state post-quantitative tightening (QT).

Citi analysts remain cautious, stating, "We still don’t view front-end spreads as cheap here."

On the volatility front, both fundamental and technical factors are expected to support implied rates volatility. Citi recommends being "long 6m10y vol with delta hedging ahead of the Fed cuts and the election," noting that 10-year tails appear cheap relative to 5-year and 30-year tails.

In terms of U.S. Treasuries (USTs), while there was continued demand from foreign private investors in May, the bank says official demand decreased as reserve managers sold USTs to protect their currencies.

Overall, "foreign holdings of long-term USTs increased by $25bn on a valuation adjusted basis," while T-bill holdings decreased by $10bn, led primarily by Japan's actions to fund their FX intervention, writes the bank.

As the FOMC meeting approaches, market participants will be closely monitoring economic data and Federal Reserve communications. Citi's latest trade recommendations and open positions reflect a strategic approach to navigating the anticipated market movements.

Whether the week will deliver a rally remains to be seen, but the bank notes that the historical trend and current analyses provide a cautiously optimistic outlook.