Wildcards: Tail Risks in an Increasingly Fragile World

A new Must C report from Citi Research economists and strategists looks at nine potential “wildcards” that investors should be aware of. While none of these scenarios is among our base cases, any of them could reshape our world in the near future. And as we note, the 2020s has seen a string of unexpected events arrive at a rapid rate: COVID, Russia-Ukraine war, the advancement of artificial intelligence (AI), and trade wars.

Our wildcards can be assigned to three themes. The first (Wildcards 1-5) concerns the shift from a unipolar to a multipolar world. The second (Wildcards 6-8) is related to asset bubbles popping. And the third (represented by standalone Wildcard 9) is specific to Europe, imagining a growth renaissance that sees the Eurozone economy grow at a faster rate similar to the U.S.

Wildcard #1: Global Fragmentation

U.S.–Europe and U.S.–China trade and political tensions could escalate further and bring about a deeper global fragmentation, pushing tariffs and non tariff barriers sharply higher and accelerating decoupling of economic powers. The U.S., Europe and China are the three largest economies in the world, collectively accounting for nearly 60% of global GDP and 40% of global trade, and this scenario would have material ramifications for the world’s economy. We see trade as the likely first transmission channel, followed by tech, investment, and geopolitics — rare earths, NATO durability, and Treasury holdings all could come into play. Such a scenario would likely mean substantially lower growth in all three economies and worldwide. Supply chains would seize, re routing slowly and imperfectly, with stagflationary pressures rising. Central banks would face a growth/inflation trade off and likely prioritize activity with faster cuts.

Wildcard #2: Perception as Risk — Foreign Buyer Strike Narrative

We don’t expect a structural foreign exit from U.S. fixed income, whose foundational role in global portfolios make such a shift impractical. But we acknowledge the narrative of a “foreign buyer strike” can move markets independently of flows, as seen after last year’s Liberation Day tariffs. Auction takedowns and Treasury International Capital data still signal healthy demand, yet hedged yield math, rising non U.S. sovereign supply, and larger coupon auctions can fuel anxiety. The risk is a duration led shock if foreign insurers pare long end exposure, pressuring utilities, tech, and bank funding curves.

Wildcard #3: Faster Than Expected RMB Appreciation

We think China could accelerate renminbi (RMB) appreciation beyond market expectations (and the conventional wisdom) in an effort to ease trade frictions, advance RMB internationalization, and support “go global” corporate strategies. A stronger currency could be a low cost bargaining chip amid potential Trump–Xi meetings and mounting scrutiny of China’s outsized goods surplus. Policymakers could also seek to enhance the appeal of RMB assets after weak inflows and lackluster China government bond performance in U.S. dollar (USD) terms.

Wildcard #4: Monroe Doctrine Extreme — U.S. Blockades Americas Oil

We consider a scenario in which the U.S. hinders or even stops exports of Latin American — or broader Americas — crude oil to the world. Such a shock would rival the 1973 Arab oil embargo, dislocating benchmarks: Brent/Dubai could spike while WTI/WCS/Mars/Maya would be discounted on captive supply and storage stress. Second order geopolitical responses from China, Europe, OPEC+, and others would add volatility. Over time, energy-security efforts could accelerate, but near term inflation outside the Americas would likely jump while parts of the Americas could see disinflationary pressure.

Wildcard #5: U.S.–Iran War or Iranian Civil Conflict

Our base case is likely pressure without escalation, potentially culminating in de escalation. But paths to conflict remain: strikes on nuclear and energy assets, retaliatory attacks on regional infrastructure, and threats to the Strait of Hormuz. A moderate disruption scenario implies durable risk premia in oil (and possibly greater beta in European natural gas). An extreme case — Strait transit impairment or internal Iranian fragmentation — could deliver substantial supply outages and price spikes.

Wildcard #6: End of the JPY Carry Trade

Relative rates spreads, strong equities and domestic economics could drive a stronger Japanese yen (JPY), especially if hedge ratios or domestic asset allocations shift. Narrow positioning metrics understate the broader system: Japan’s ~¥1,500 trillion in net foreign assets underpin funding across portfolios, with lower foreign exchange (FX) hedging ratios on USD-denominated assets after years of JPY weakness. We forecast sub ¥145/$ against the USD by year’s end, and USDJPY could fall below ¥140 if there’s unwinding of JPY-funded carry trades. JPY carry trades have been structurally built in the global market; an unwinding would cause a far faster and stronger currency appreciation than we currently assume.

Wildcard #7: Bursting AI Bubble, Aggressive Fed Cuts

We see U.S. equities in bubble territory. Bubbles can extend on liquidity, but unwind risks rise if inflation stays sticky and the Fed leans hawkish, or if the return on investment on AI capex disappoints. A sharp drawdown would transmit via wealth effects, risking recession and driving aggressive Fed cuts while Treasuries rally. The USD might weaken with a lag. Equity rotation would likely mirror 2000: out of tech and cyclicals, into defensives and rate sensitives, with geographic diversification offering only limited shelter.

Wildcard #8: AI Hits Credit

We see AI driven disruption as particularly acute for leveraged credit where software and insurance exposures are concentrated, notably in business development companies and loans. Pricing has tracked leverage and market-cap tiers, with smaller, more fragmented software names underperforming. We anticipate a widely dispersed range of outcomes, with AI-related disruption causing both clear winners and losers to emerge; some companies will successfully leverage AI to enhance operations, while others may face obsolescence. This asymmetrical risk-reward profile is particularly problematic for credit instruments, which inherently offer limited upside against significant downside risk. We see two potential avenues for the AI disruption theme to affect financial conditions — through loan ETFs and the generation of collateralized loan obligations (CLOs). While ETFs are only 2% of the loan market, their daily liquidity causes an outsized effect on market conditions. CLOs, meanwhile, are the primary buyer of loans, with 71% of the loan market. Any slowdown in CLO issuance would materially tighten financial conditions for issuers that rely on lenders for capital, which could trigger a cycle of higher distress rates and deeper secondary-market selloffs.  

Wildcard #9: EU Exceptionalism — U.S.-Style 2.5% Growth

We consider a low probability but plausible EU economic growth renaissance toward ~2.5% over three to four years. A pivot inward — marked by more fiscal outlays, reshored supply chains, additional capex on multiple fronts — could spark a manufacturing rebound and productivity lift, initially tempering inflation and delaying the European Central Bank’s hawkishness. The equity implications would include faster EPS growth and P/E re rating, narrowing the U.S. premium. FX could respond via flow rotation from U.S. equities, echoing early 2000s dynamics; under similar conditions, EURUSD could appreciate materially, though the path depends on relative policy and inflation trajectories.