US Treasury Poised to Unleash $1 Trillion in Bonds After Debt Ceiling Deal
US Treasury Poised to Unleash $1 Trillion in Bonds After Debt Ceiling Deal

By Andrew Moran

The U.S. Treasury is poised to replenish its bank account at the Federal Reserve, now that the bipartisan debt ceiling agreement has been signed, sealed, and delivered.

The Treasury’s cash balance–the Treasury General Account (TGA)–sank below $23 billion on June 1, according to the Daily Treasury Statement. That compares to the roughly $316 billion at the beginning of May.

Market observers say there will be a near-record issuance of short-term U.S. government debt to refill the Treasury’s coffers quickly. It’s estimated that Washington could offer as much as $1.4 trillion in T-bills over the next six months to facilitate a return to balance, which could also resume funding daily needs and obligations.

If the projections are accurate, this would be second only to the level of issuance the department executed during the COVID-19 pandemic.

The sales were scheduled to begin on June 5.

There are growing concerns that this could initiate a credit crunch and potentially disrupt the financial markets at a time when the U.S. economy is showing signs of slowing and the banking system is still reeling from recent banking turmoil.

But while there’s typically a diverse array of buyers for short-term securities, such as money market funds, financial institutions, and pension funds, there’s some concern that banks could sit on the sidelines during the Treasury auctions because of disinterest. That’s because the government’s yields may not be able to compete with what banks can receive from their reserves.

“The imminent near-term increase in the TGA and the Federal Reserve’s continuation of quantitative tightening impact the total amount of reserves in the system,” warned Scott Freidenrich, former BNY Mellon Treasurer and now a senior adviser to FTI Consulting. “This, combined with the potential for further central bank rate hikes to combat inflation, increases the potential for deposit volatility and fluctuations in the value of securities portfolios.”

However, some experts contend that the concerns are exaggerated since there’s plenty of cash sitting in short-term markets, and investors might want to use that money for additional yield.

Today, about $2 trillion in money market assets are parked in the Federal Reserve overnight facility, also known as the Overnight Reverse Repo Facility (ON RRP). This central bank mechanism injects liquidity into the financial system and manages short-term interest rates.

Any significant increase in the Treasury General Account “would have to be offset by reductions in either the ON RRP or bank reserves,” according to T. Rowe Price analysts.

“The Fed has less control over the liability side of its balance sheet, which could complicate the job of managing the impact of a surge in Treasury debt issuance,” portfolio manager Adam Marden and corporate credit analyst Pranay Subedi wrote in a research note. “History suggests that as much as 80 percent of the balance sheet adjustment needed to offset a TGA increase of the size contemplated could come from a reduction in bank reserves.”

Ultimately, issuance could threaten additional draining of bank reserves, the T. Rowe Price analysts noted.

The Treasury and the Fed

This past fall, Treasury Secretary Janet Yellen conceded that she was concerned about liquidity conditions in the Treasury market, noting that volumes had diminished.

“It’s not unexpected that in a world of increased volatility that liquidity should diminish somewhat or the cost of transacting might rise a little, but my assessment is that markets are well functioning, trading volumes are large, traders are not having difficulty executing trades,” Yellen told the Securities Industry and Financial Markets Association at an event in October 2022.

“Treasury is working with financial regulators to advance reforms that improve the Treasury market’s ability to absorb shocks and disruptions, rather than to amplify them.”

U.S. Treasury Secretary Janet Yellen presides over the unveiling of the first U.S. banknotes printed with two women’s signatures at an event in Fort Worth, Texas, on Dec. 8, 2022. (Shelby Tauber/Reuters)

Officials don’t appear concerned as the Treasury has been planning for sizable auctions for the past month.

Minutes from the May 2 Treasury Borrowing Advisory Committee suggest that officials say $600 billion in issuance over three months wouldn’t result in stress in the financial markets, citing primary dealers’ estimates. But Treasury Debt Manager Tom Katzenbach “noted that dealers encouraged Treasury to be responsive to potential market-based indicators of stress in the bill market when replenishing its cash balance.”

Past data could confirm that there’s no backlash in the financial markets from enormous debt issuance.

During the 2019 and 2021 debt ceiling fights, when the Treasury employed extraordinary measures and drained its TGA, substantial bond issuance didn’t illustrate adverse effects on equities. But some critics suggest that these events didn’t coincide with stress in the financial sector.

It’s unclear if the Federal Reserve intends to scoop up Treasurys.

The U.S. central bank is presently engaged in its quantitative tightening cycle. A part of this initiative is reducing the size of its Treasury securities by allowing them to mature. For the week that ended on June 1, the Fed’s total holdings of government bonds had fallen below $5.2 trillion.

That said, should there be outflows in bank reserves, it could leave short-term funding markets “vulnerable.” This would create “the possibility that the Fed might halt efforts to shrink its balance sheet in the back half of 2023,” according to the T. Rowe Price report.

In total, the Fed’s balance sheet stands at roughly $8.4 trillion.

While the debt ceiling drama will be on hold until January 2025, the unfolding events may spark consequences for the markets in the coming months.

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