Citrini sees coordinated Fed-Treasury policy supporting long-term bonds

Treasury and Federal Reserve policies are moving toward a more coordinated approach that could shift government borrowing toward short-term bills and reduce the supply of longer-dated Treasuries, Citrini Research said.

The firm called the potential policy framework a new “Treasury-Fed Accord.” It expects the Federal Reserve to shrink its balance sheet while commercial banks expand theirs and absorb more Treasury bills.

Citrini recommended betting that 30-year bonds will outperform five-year notes, with the yield gap narrowing over the next three months through the Treasury’s Nov. 4 refunding announcement.

The firm said changes to liquidity rules could allow banks to hold less cash and lend more. It identified Bank of America, US Bancorp, Truist Financial and Capital One as potential beneficiaries.

Citrini said Bank of America’s mortgage bonds bought in 2020 and 2021 lost value as rates rose, leaving the bank reliant on securities-backed borrowing. A regulatory change could allow it to reduce that borrowing and resume growth, the firm said.

The thesis follows Treasury Secretary Scott Bessent’s plan to increase buybacks of long-term bonds. His “Treasury twist” could replace some longer-dated debt with bills after 30-year yields reached their highest level in almost two decades.

Citrini said Fed Chair Kevin Warsh and Bessent appear aligned on reducing the Fed’s market footprint, improving fiscal sustainability and encouraging bank lending. Warsh is scheduled to speak at Jackson Hole on Friday and has advocated for a smaller Fed balance sheet.

Beyond the next few months, Citrini remains bearish on long-term bonds. It said keeping nominal economic growth above the government’s borrowing cost could leave bondholder returns below inflation and that lower yields could encourage more borrowing and inflation pressure.