The U.S. Treasury market might be heading for a strange turning point. A week ago, the Treasury Department said it would at least double its long-end buyback operations to a minimum of $4 billion each. Citrini Research now thinks investors may have misread what that move is really about.
The firm has initiated a five-year/30-year flattener, betting that the gap between five-year and 30-year Treasury yields will narrow over the next three months. The potential catalyst is Treasury's next quarterly borrowing plan on Nov. 4. By then, Citrini expects a "Treasury twist" to become visible to the market.
Someone Has To Buy The Debt
The problem starts with the Federal Reserve. Fed Chair Kevin Warsh wants a smaller Fed balance sheet. Treasury Secretary Scott Bessent, meanwhile, wants lower long-term borrowing costs. That creates an obvious question: if the Fed buys less government debt, who replaces it?
Citrini's answer is the banking system. The idea is simple. Banks currently hold large amounts of cash and safe securities to satisfy liquidity requirements. A proposed regulatory change could allow banks to rely more heavily on emergency borrowing capacity from the Fed. That would free some of the cash currently sitting idle.
Citrini cited an estimate from then-Fed Governor Stephen Miran that the change could unlock $500 billion to $1 trillion of additional lending capacity. That money could then move into the financial system. The firm calls it Accord 2.0. And this is where the Treasury trade begins.
Banks Want Bills, Not 30-Year Bonds
Banks are unlikely to rush into long-term bonds. The experience of 2023 showed why. When interest rates rise, long-duration bonds can lose significant value. The iShares 20+ Year Treasury Bond ETF (TLT) closed Wednesday at $83.30, near the multi-decade low of $81.17 it set on Aug. 18. Since the highs reached in March 2020, the popular fixed-income ETF has fallen by 55%.
Citrini therefore expects banks to prefer shorter-dated Treasury bills. That creates a problem for Treasury: if the new buyers want short-term debt, why keep issuing as much long-term debt?
The answer could be a change in the Treasury's borrowing mix. Citrini noticed a small but potentially important change in Treasury's Aug. 5 refunding statement. Previously, Treasury said it was considering potential future increases to bond auction sizes. The new statement referred instead to potential future changes. Citrini reads that as a signal that the Treasury could issue more bills and fewer long-term bonds.
That is the "Treasury twist." The government does not necessarily borrow less money. It borrows it for less time.
The 30-Year Bond Could Witness A Short Squeeze
This is where the trade gets interesting. If Treasury reduces the supply of long-term bonds while banks absorb more short-term bills, the 30-year could become relatively scarce. At the same time, traders are heavily positioned against the long bond, according to positioning data cited by Citrini. That creates the possibility of a squeeze.
"The long bond (30yr) is primed for a squeeze," Citrini said, while warning that "it's going to take some doing."
Positioning is the accelerant. Citrini is not simply betting on lower bond yields. It is betting that 30-year bonds outperform five-year bonds as Treasury changes where it borrows. Citrini expects that trade to play out through the Nov. 4 QRA, when it believes the Treasury twist will become clearer.
The bigger question is whether Treasury can actually reshape the market without creating new problems. Citrini itself remains skeptical about the longer-term consequences. But for the next three months, its message is much simpler: The biggest Treasury trade may not be about rates going down. It may be about which part of the Treasury market becomes scarce.
