The U.S. narrowly avoided default on Saturday when President Biden signed into law a bill that would allow the nearly cash-strapped Treasury Department to borrow additional money to pay the nation’s bills.
Now that the Treasury Department is starting to build up its reserves, future over-borrowing could lead to economy-shaking complications.
Banks estimate that the government will borrow about $1 trillion by the end of September. This steady state of borrowing will draw cash from banks and other lenders into Treasury bills, drain funds from the financial system, and amplify pressure on lenders in already stressed regions. deaf.
To get investors to lend so much money to the government, the Treasury Department faces rising interest costs. Given that many other financial assets are pegged to government bond rates, higher government borrowing costs will also raise costs for banks, corporations and other borrowers, prompting the federal government to raise interest rates by roughly one to two quarter points. may have similar effects. reserves, analysts warn.
“The root cause remains largely the conflict over the debt ceiling,” said Gennady Goldberg, rates strategist at TD Securities.
Some policymakers have suggested they may choose to pause rate hikes at next week’s central bank meeting to assess how policy has affected the economy. The Treasury Department’s refinancing would in any event push up borrowing costs, so that decision could be reversed.
That could exacerbate investor and depositor concerns that flared up in the spring about how higher interest rates have eroded the value of assets held by smaller banks.
The surge in Treasury debt will also amplify the impact of shrinking the balance sheet, another Fed priority. The Fed has cut back on the number of new Treasuries and other bonds it buys, slowly shrinking older ones, and retail investors already have more debt to absorb.
“The potential damage to the economy would be extraordinary if the Treasury were to sell so much Treasury bonds to the market,” said Christopher Campbell, who served as Assistant Treasury Secretary for Financial Institutions from 2017 to 2018. “It’s hard to imagine the Treasury going to the market and selling a lot of Treasury bonds,” he said. It could be a trillion dollar bond, but it won’t affect borrowing costs. ”
Cash in the Treasury Department’s general account fell below $40 billion last week as lawmakers scrambled to reach a deal to raise the country’s borrowing ceiling. Mr. Biden on Saturday signed a bill that would suspend the $31.4 trillion debt limit until January 2025.
For months, Treasury Secretary Janet L. Yellen played an accounting game known as an unusual move to delay default. This included a moratorium on new investment in postal and civil servant retirement funds.
Recovering these investments is basically a simple accounting fix, but replenishing the government’s cash vault is more complicated. The Treasury Department said Wednesday it hopes to borrow enough to rebuild its cash accounts to $425 billion by the end of June. Analysts said it would need far more borrowing to cover its planned spending.
“The supply floodgates are already open,” said Mark Kavanagh, rates strategist at Bank of America.
A Finance Ministry spokesman said the ministry carefully considered investor demand and market capacity when deciding to issue bonds. In April, Treasury officials launched a survey of key market players about how much they thought the market could absorb after the debt-limit stalemate was lifted.Federal Reserve Bank of New York this month It asked the big banks for estimates of what they expected to happen to their reserves and borrowings from certain Fed facilities in the coming months.
The ministry has managed similar situations before, the spokesperson added. Notably, after the 2019 debt ceiling battle, the Treasury Department rebuilt its cash piles over the summer, draining foreign exchange reserves from the banking system and disrupting market plumbing. , prompting the Fed to intervene to prevent things from getting worse. crisis.
One of the things the Fed has done is to establish the Gensaki contract program, a form of financing secured by Treasury bonds. The backstop could provide a safety net for banks short on cash to lend to governments, but its use was widely seen in the industry as a last resort.
A similar but inverse program, which offers Treasury collateral in exchange for cash, currently holds more than $2 trillion, most of which struggle to find attractive and safe investments. is from a money market fund that Some analysts say this is sideways money that could flow into Treasury accounts as the Treasury offers more attractive interest rates on debt and reduces the impact of borrowing. I see that there is.
But the practice of governments selling Treasuries and deducting reserves held by the Fed in exchange for new notes and bonds could still test the resilience of some smaller financial institutions. As reserves dwindle, some banks may run out of cash, while investors and others have turned to financial institutions they deem to be in trouble, given recent concerns about some parts of the industry. may be reluctant to lend.
That would force some banks to rely on separate Fed facilities set up in the midst of this year’s banking industry turmoil to provide emergency funding to depository institutions at relatively high costs. there is a possibility.
“One, two, three banks may be underprepared and suffer the consequences,” said Goldberg of TD Securities. There is,” he said.