Citrini, the author of high-profile forecasts, saw a “regime change” in the policies of the Fed and the Treasury Department

The U.S. Treasury and the Fed are moving toward a more coordinated policy that could shift government borrowing toward short-term debt and reduce the supply of long-term Treasury bonds. This sets the stage for a rally in 30-year U.S. Treasuries, according to research firm Citrini Research. The firm attracted attention earlier this year when it issued a grim forecast of an economic collapse triggered by the development of AI, sending the market tumbling.

Citrini Research believes that changes in banking regulation, the Treasury Department’s management of public debt, and the Federal Reserve’s policy regarding its balance sheet are coming together to form a new system. The company views these developments as a “regime shift” and refers to a new “agreement between the Treasury and the Fed.” Under this model, the Fed will reduce its balance sheet, while commercial banks, on the contrary, will expand theirs. They will be able to absorb more Treasury bills, as the Treasury will shift its issuance of government debt from longer maturities to short-term securities. A reduction in the supply of long-term bonds could lead to a decline in their yields, according to Citrini.

"We believe that the officials responsible for monetary and fiscal policy—Federal Reserve Chair Kevin Warsh and Treasury Secretary Scott Bessent—have reached a common approach," Citrini's note states.

According to the research firm, this plan is intended to address several objectives simultaneously: reduce the Fed’s presence in financial markets, improve the stability of public finances, and stimulate economic growth by easing restrictions on banks and allowing them to lend and invest more actively.

Against this backdrop, the researchers recommended that their clients make a short-term bet on 30-year bonds outperforming 5-year bonds—that is, on a narrowing of the yield spread between them, Bloomberg explains.

The company expects this spread to narrow over the next three months—until the Treasury’s next announcement on debt refinancing parameters on November 4. “By that time, we believe the Treasury twist will already be apparent to the market,” the company writes, referring to Bessent’s plan to at least double the volume of long-term Treasury bond buybacks.

However, over the longer term, Citrini continues to take a negative view of long-term bonds. The company believes that Bessent’s strategy—which assumes that nominal economic growth will remain above the government’s borrowing costs—could result in bondholders’ returns lagging behind inflation.

In addition, falling yields could encourage further borrowing and thereby further intensify inflationary pressures, Citrini warns.

Last week, Bessent announced plans to increase the volume of buybacks of long-term government bonds to ease pressure on the market after yields on 30-year bonds rose to their highest level in nearly two decades. As part of a strategy the Treasury Secretary has dubbed the “Treasury twist,” the department may buy back more long-term securities and increase the issuance of short-term ones—effectively replacing part of the long-term debt with short-term notes, according to Bloomberg.

Warsh, who is set to deliver his first keynote address on Friday at the annual symposium in Jackson Hole, has long advocated for reducing the Fed’s balance sheet, the agency notes. One of the working groups established to reform the regulator’s operations is tasked with reviewing both the size of the balance sheet and the maturities of the assets on it.

Warsh also spoke of the need for a new “agreement between the Fed and the Treasury,” though he did not explain in detail what form it should take. The original 1951 agreement, on the other hand, strengthened the Fed’s independence from the Treasury and put an end to the policy of keeping the cost of government borrowing down by limiting bond yields, Bloomberg notes.

Deutsche Bank, Morgan Stanley, and Citigroup also consider a more radical option: the Ministry of Finance could directly reduce the volume of long-term bond issuances. However, they consider it more likely that the ministry will signal that further borrowing will be financed through Treasury bills and bonds with shorter maturities. At the same time, the Ministry of Finance may further expand its bond buybacks to ease pressure on long-term bond yields.

"The bond market is entering a 'whole new world' of U.S. public debt management," said Megan Swiber, managing director of U.S. interest rate strategy at Bank of America, in an interview with Bloomberg.

"Bessent's actions have effectively made the November refinancing announcement far less predictable than it would have been under normal circumstances," the agency quotes Ian Lingen, head of U.S. rate strategy at BMO Capital Markets, as saying. “A reduction in the volume of Treasury auctions can no longer be ruled out,” he noted.

This article was AI-translated and verified by a human editor