A wave of $1 trillion in US government borrowing will add pressure to the nation’s banking system as Washington returns to markets in the wake of its debt-ceiling battle, traders and analysts say.
Following the resolution of that dispute – which previously prevented the US from borrowing more – the Treasury Department will try to rebuild its cash balance, which reached its lowest level since 2017 last week.
JPMorgan has estimated that Washington will need to borrow $1.1 trillion in short-term Treasury bills by the end of 2023, with $850 billion in net bill issuance over the next four months.
One of analysts’ main concerns was that the volume of new issuance alone would drive up government debt yields, sucking money out of bank deposits.
“Everyone knows the flood is coming,” said Gennadiy Goldberg, a strategist at TD Securities. “This flood will increase yields. Treasury bills will continue to become cheaper. And that puts pressure on the banks.”
He said he expected the largest increase in Treasury bill issuance in history, except during crises such as the 2008 financial collapse and the 2020 pandemic. Analysts said the bills would run from a few days to a year.
The Finance Department guidance offered on Wednesday and said it aims to return its cash balances to normal levels by September. JPMorgan said the announcement was roughly in line with general estimates. The Treasury also said it would “closely monitor market conditions and adjust its issuance plans as necessary.”
Yields have already begun to rise in anticipation of increased supply, added Gregory Peters, co-chief investment officer of PGIM Fixed Income.
That shift adds pressure to U.S. bank deposits, which have already fallen this year as rising interest rates and the bankruptcy of regional lenders have prompted customers to look for higher-yield alternatives.
A further flight of deposits and the rise in yields could in turn prompt banks to offer higher interest rates on savings accounts, which could be costly, especially for smaller lenders.
“The rise in interest rates could force banks to raise their deposit rates,” said Peters.
Doug Spratley, head of the cash management team at T Rowe Price, agreed that the Treasury’s return to borrowing “could exacerbate tensions already on the banking system.”
The supply shock comes as the Fed is already reducing its bond holdings, unlike in the recent past when it was a big buyer of government debt.
“We have a significant budget deficit. We still have quantitative tightening. If we also get a wave of T-bill issuance, we are likely to have turbulence in the Treasury market in the coming months,” said Torsten Slok, chief economist at Apollo Global Management.
After the bank failures of this spring, bank customers have already switched strongly to money market funds that invest in corporate and government bonds.
According to data from the Investment Company Institute, an industry group, the stock of funds in money market accounts hit a record high of $5.4 trillion in May – up from $4.8 trillion at the start of the year.
But while money market funds are typically big buyers of Treasury bills, they are unlikely to buy up the entire supply, analysts said.
This is largely because money market funds are already receiving generous risk-free returns – currently 5.05 percent annualized – on the overnight funds left with the Fed. This is only slightly less than the 5.2 percent available on the comparable Treasury rate, which carries more risk.
Currently, about $2.2 trillion per night is poured into the Fed’s overnight reverse repurchase agreement (RRP) facility, largely from money market funds.
That money could be redeployed to buy Treasury bills if they yield significantly higher yields than the Fed’s facility, analysts said. But the RRP rate moves with interest rates. So if investors expect the Fed to continue tightening monetary policy, they will likely park their cash overnight at the central bank, rather than buying bills.
“While (money market funds) with RRP access could buy some T-bills on margin, we believe this will likely be small compared to other types of investors (such as corporates, bond funds without access to the RRP facility and foreign buyers) ,” Jay Barry, co-lead interest rate strategy at JPMorgan, wrote in a note.
Last week’s landmark employment data for May added to the pressure by reinforcing investor expectations that further rate hikes are imminent – which could reduce appetite for government debt at current rates.
