America Faces Debt Flood After Debt Ceiling Negotiations

H.make out Congress has frantically avoided a sovereign default and decided to allow the government to resume borrowing. But even though the debt ceiling talks are over, the aftershocks will ripple through financial markets over the coming months. To avert disaster, the Treasury has spent most of the past six months depleting its cash holdings, eventually reaching a state of almost nothing. There is now a rush to replenish cash, posing a potential danger to the economy.

The Treasury General Account, the Federal Reserve’s main government account used for public payments, was down to just $23 billion as of early June, well below net spending on a typical day. there is Normally, the Treasury Department tries to maintain at least $500 billion in balances to cover about a week’s worth of cash outflows. Its task is therefore to sell notes and bonds to rebuild the buffer (it will rely primarily on notes as it is easier to raise cash quickly by selling short-term bonds). At the same time, more paper will have to be sold to cover the government’s deficit. As a result, the issuance amount will increase rapidly. Bank of America’s Mark Kavanagh expects the Treasury to issue more than $1 trillion in bills over the next three months, about five times the average summer total.

The concern is where the money will come from, especially if bond sales will drain liquidity from other asset markets. There are two main possible sources of cash, each with its own risks. The first is the money market fund, with over $5 trillion invested at the moment, and the money is piling up. In principle, these funds could raise most of the new notes simply by deducting cash deposited with the Federal Reserve through the reverse repo (repo) facility. But for that to happen, the Treasury may need to offer a higher coupon rate than the 5.05% reverse repo yield. Higher yields could lead to higher funding costs for already-tough local banks, which is not an attractive prospect.

The second option is still unattractive. Corporations, pension funds and other investors could end up being the biggest buyers of bills, meaning moving funds from deposits to the Treasury and lowering the level of reserves in the financial system. become. Banks have about $3 trillion in excess reserves. It won’t take long for these to drop to $2.5 trillion. This level is seen by many as indicative of a shortfall in reserves (rule of thumb suggests banks should keep reserves at around 10% of $2.5 trillion). GDP). Such a development could raise uncomfortable questions about bank stability and force lenders to offer higher deposit rates to collect reserves.

A temporary shortage of reserves does not necessarily mean disaster. The Fed may provide liquidity support if needed. And the more money market funds buy, the less pressure on bank reserves. But in any case, Treasury issuance will almost certainly increase market anxiety and volatility, increasing the risk that something will go wrong somewhere. There’s one more thing I don’t like about America’s perpetual debt ceiling mess.

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