New Treasury-Fed Accord Seen Narrowing 5-30 Year Spread in 3 Months

A coordinated Treasury-Fed framework that shifts government borrowing toward short-dated bills will narrow the 5-year to 30-year yield spread within three months, Citrini Research said, betting on a rally in long-dated Treasuries.

"We expect the monetary and fiscal authorities — Fed Chair Kevin Warsh and Treasury Secretary Scott Bessent — to have agreed on a framework" that shrinks the Fed's balance sheet, improves fiscal sustainability, and frees banks to lend more, the firm wrote in a report.

The trigger is Bessent's surprise plan to expand buybacks of long-dated bonds, a "Treasury twist" that replaces some long-term debt with short-term bills. The 30-year yield climbed to its highest since 2007 before the announcement. Citrini expects the 5y-30y spread to narrow meaningfully around the Nov. 4 refunding announcement, when the effect of the twist is fully visible.

At stake is the cost of government borrowing and the path of inflation. If the framework holds, long yields fall and bank profits rise; if not, the adjustment shows up in a weaker dollar and higher import prices.

The framework rests on three interlocking policy variables: bank regulatory reform, Treasury debt-management strategy, and Fed balance-sheet policy. Under the new accord, the Fed keeps shrinking its balance sheet while commercial banks expand theirs to absorb more short-term bills. The Treasury shifts issuance from long maturities to short ones, directly cutting the supply of long-dated bonds reaching the market.

Warsh is the central figure. He is scheduled to speak Friday at the annual Jackson Hole symposium and has long pushed to shrink the Fed's balance sheet, setting up a task force to review its size and duration profile. The original 1951 Treasury-Fed Accord gave the Fed independence and ended the policy of capping bond yields to hold down government borrowing costs; the new version runs in the opposite direction, emphasizing coordination rather than independence.

Banks Named Biggest Winners of Looser Rules

Citrini named Bank of America, US Bancorp, Truist Financial and Capital One as the main beneficiaries of looser liquidity rules, which would let banks hold less cash and free up lending capacity. Bank of America bought large volumes of low-rate mortgage bonds in 2020-2021; as rates rose, their book value shrank, and because liquidity rules mark bonds at fair value, the buffer narrowed, forcing the bank into securities-backed funding. Citrini called that borrowing "a drag — costlier than it's worth and subject to size limits on big banks." A rule change would let the bank drop it and return to growth, narrowing its valuation discount to peers.

The bullish call has a clear time boundary. Citrini expects the spread compression window to run about three months, around the Nov. 4 refunding announcement. Beyond that, the firm stays bearish on long-dated Treasuries: Bessent's strategy of keeping nominal growth above government borrowing costs will leave bondholders' real returns trailing inflation, and lower yields could encourage more borrowing, adding to price pressures.

Dissenting Views on the Buyback Program

The view is not unanimous. Citadel Securities reversed its bearish stance on long-dated Treasuries, warning that crowded short positioning raises the risk of a painful unwind. Stanley Druckenmiller called the buyback expansion a "mistake" driven by "price management" that will fail, arguing only deficit reduction can sustainably lower long yields. Bessent rejects that reading, saying the program supports liquidity, not rate control. "We haven't bought a single bond yet," he said. Evercore ISI's Krishna Guha called it "a weak form of Operation Twist," warning it could backfire if markets read it as a sign Washington is struggling to borrow cheaply.

The Treasury raised the per-operation buyback ceiling from $2 billion to at least $4 billion for the 10-to-20-year and 20-to-30-year sectors, with the larger operations running from Sept. 9 through Nov. 4. It has also weighed drawing on its roughly $1 trillion General Account to help fund the program. Japan holds about $1.12 trillion in Treasuries, roughly 12 percent of reported foreign holdings, and limiting the risk of forced sales by Japanese investors was a plausible motive behind the Treasury's willingness to support the Japanese Ministry of Finance, Citadel Securities said.

This article is for informational purposes only and does not constitute investment advice.