(Bloomberg) – Bond traders are likely to shift from concerns that the US will not raise its debt ceiling to concerns about what the hike means for money markets.
Most Read by Bloomberg
There is concern that the Treasury Department will soon replenish its cash stash by selling more than $1 trillion in banknotes by the end of the third quarter as the tentative agreement approaches, according to the latest estimates. The US cash balance is currently at $39 billion, the lowest since 2017.
A deluge is likely to drain significant amounts of liquidity from the financial markets. This could add pressure as the Federal Reserve has hiked rates and reduced its balance sheet.
A $1 trillion tide of Treasury bills is a painful risk of a debt limit agreement
As the Treasury competes with banks for cash, lenders themselves may see their short-term financing rates rising, forcing them to increase the borrowing costs they impose on businesses and households.
Analysts at Bank of America Corp. have estimated that this would have the same economic impact as a quarter-point rate hike, pressures that would materialize as traders are already predicting the Fed could hike interest rates by another 25 basis points by July.
The result is that while short-term government bond yields could fall on the back of a deal, the fall would be limited as investors try to gauge what comes next.
“There will be a knee-jerk reaction in government bonds as this area of the market has borne the burden of uncertainty,” said Kevin Flanagan, head of fixed income strategy at Wisdomtree Investments, on Friday. “So yields are coming down from their highs, but with the Treasury going to increase issuance, there is a yield floor for this market.”
The story goes on
Biden and McCarthy forge a debt limit agreement to avert a US default
cash stash
The dispute over the debt ceiling has created tensions in the markets as investors are demanding higher yields on securities that are due to be redeemed shortly. Interest rates on instruments maturing in early June topped 7% at times last week. The price of credit default swaps — derivatives that allow investors to hedge against defaults — peaked well above levels seen in the 2011 debt limit episode.
The US cash balance, or Treasury general account, will increase to $550 billion by the end of June and reach $600 billion three months later, according to the department’s estimates earlier in the month.
Efrain Tejeda, short-term interest rate strategist at Morgan Stanley, forecasts that Treasury bill issuance will total $730 billion over the next three months and about $1.25 trillion in the June-December period. During the 2017–2018 debt ceiling phase, the Treasury issued $500 billion in banknotes in about six weeks.
repo puzzle
A key piece of the puzzle is the Fed’s reverse repurchase agreement facility — called the RRP — under which money market funds park cash overnight at the central bank at a rate of just over 5%.
This program — currently over $2 trillion — is also a burden on the Fed. If the Treasury account goes up but EIAs go down, the strain on bank reserves would be less.
Matt King, a strategist at Citigroup Inc., has warned that the tendency for money funds to hold cash in EIAs will most likely continue, which could mean a significant drain on reserves if Treasury liquidity surges.
Most Read by Bloomberg Businessweek
©2023 Bloomberg LP
Comments are closed.