As Citigroup Indicates To Investors That Trading Revenue Slipping, Is A 1994-Style Bond Rout In The cards?

Citigroup is poised to post a meaningful drop in trading revenue for the soon-to-close third quarter due to a slowdown in business as uncertainty about Federal Reserve policy and subsequent declines in sensitive assets like U.S. bonds and emerging markets unsettle Wall Street's big firms.

Citi’s business model leans towards interest rates and foreign exchange, currently weak across Wall Street. Citi (NYSE:C) is also among the firms most exposed to emerging markets that have experienced capital flight and major currency declines.

According to a Financial Times report on Sunday that cited people privy to Citi's investor discussions, the bank looks to join other large bond traders in reporting a decline in revenue after a summer slowdown in business.

Citi refused to comment on the matter to the paper.

“There are two things that happened,” said Adam Sarhan of Sarhan Capital. “Number one, the Fed said on May 22 that it was going to taper (trim back its buying of troubled U.S. assets), then a few weeks later Bernanke did a 180 and said he’s not going to taper, and that caused a 7.5 percent pull back in the S&P 500 and caused interest rates to spike higher. So in effect, it’s two major markets that these banks trade in, equities and bonds that are going to suffer.”

That has led many investors, at least those with a couple of decades of experience, to ask themselves if a replay of 1994's historic bond market rout may be setting itself up.

Back in January 1994, America had experienced its 34^th month of economic expansion, inflation was minimal and bond yields were historically low. Salaries were steady and consumer prices had leveled out. Several months later, the worst bond market loss in history began to unfold.

Fast forward 19 years and investors may be forgiven for wondering if a repeat of that rout is taking form. Those investors will be closely watching earnings reports from Citi and rivals like J.P. Morgan Chase & Co. (NYSE:JPM) and Goldman Sachs Group Inc. (NYSE:GS) for any indications where things are headed.

The market has been spooked since at least this February after yields on 10-year U.S Treasurys, Australian 10-year government bonds and British 10-year gilts all fell to record lows of 1.39 percent, 2.8 percent and 1.44 percent, respectively. Since then, the 10-year bond yield has soared to nearly 3 percent.

Sarhan says that it is the Fed’s flip-flopping and its indecision with regard to easing back on bond purchases that has kept rates at historic lows.

But Sarhan doesn’t rule out the possibility of a 1994-style bond crash.

"We haven’t seen it yet, doesn’t mean we’re not going to see it. It’s very possible that we could see a bond crash, see yields spike up if the fed loses control," said Sarhan.