President Biden signed a law on Saturday that would prevent the United States from defaulting on allowing the Treasury Department, which was dangerously close to running out of cash, to borrow more money to pay the nation’s bills. Saved by the mistake.
Now, the Treasury is starting to build up its reserves, and the ensuing borrowing could lead to complications that would shake the economy.
According to estimates by several banks, the government is expected to borrow around $1 trillion by the end of September. This stagnant borrowing position is set to draw cash from banks and other lenders into Treasury securities, siphoning money out of the financial system and adding to the pressure on already stressed regional lenders.
To entice investors to lend such large sums to the government, the Treasury faces rising interest costs. Given how many other financial assets are tied to the Treasury rate, higher borrowing costs for the government also raise costs for banks, companies and other borrowers, and roughly one or two quarter-point rate hikes from the federal government are expected. can produce a similar effect. Reserve, analysts warn.
“The root cause is still the entire debt ceiling impasse,” said Gennady Goldberg, an interest rate strategist at TD Securities.
Some policymakers have indicated they may opt to take a break from raising rates when the central bank meets next week to assess how policy has affected the economy so far. Treasury’s cash reconstruction could undermine that decision, as it would make borrowing costs higher.
This in turn could fuel concerns among investors and depositors that flared up in the spring about how higher interest rates eroded the value of assets at small and medium-sized banks.
The deluge of Treasury debt also magnifies the effects of another Fed priority: shrinking its balance sheet. The Fed has reduced the number of new Treasuries and other debt it buys, gradually allowing older debt to roll over and already leaving private investors to absorb more debt.
“The potential impact on the economy once Treasuries sell off in the market could be extraordinary,” said Christopher Campbell, who served as assistant Treasury secretary for financial institutions from 2017 to 2018. There could be $1 trillion worth of bonds and not having that affects the cost of borrowing.
The cash balance in the Treasury Department’s general account fell below $40 billion last week as lawmakers raced to reach an agreement on raising the nation’s borrowing limit. Mr Biden signed legislation on Saturday that suspended the $31.4 trillion debt ceiling until January 2025.
For months, Treasury Secretary Janet L. Yellen was using accounting maneuvers known as extraordinary measures to delay default. These included suspending new investments in retirement funds for postal workers and civil servants.
Restoring those investments is essentially a simple accounting, but replenishing the government’s cash coffers is more complicated. The Treasury Department said on Wednesday it expected to borrow enough to get its cash account back up to $425 billion by the end of June. Analysts said much more borrowing would be required for the planned spending.
“The supply floodgates are now open,” said Mark Cabana, an interest rate strategist at Bank of America.
A Treasury Department spokeswoman said that in making decisions on whether to issue loans, the department carefully considered investor demand and market potential. In April, Treasury officials began surveying major players in the market about how much they thought the market could absorb after the resolution of the debt-limit impasse. Federal Reserve Bank of New York this month asked the big banks about their estimates of how much they expect to borrow from bank reserves and some Fed facilities in the coming months.
The spokesperson said the department has dealt with similar situations in the past. Notably, after the debt-limit wrangle in 2019, the Treasury Department rebuilt its cash pile over the summer, contributing to factors that removed reserves from the banking system and increased market plumbing, which The Fed was prompted to intervene. crisis.
One of the things the Fed did was to set up a program for repurchase agreements, a form of financing with Treasury debt posted as collateral. That backstop could provide a safety net for banks short of cash from lending to the government, although its use was widely seen in the industry as a last resort.
A similar but opposite program, which swaps out Treasury collateral in exchange for cash, now has more than $2 trillion in it, mostly from money market funds that are struggling to find attractive, safe investments. It is seen by some analysts as money on the sidelines that can flow into the Treasury’s account as it offers more attractive interest rates on its loans, mitigating the effects of a borrowing spree.
But the mechanism by which the government sells its debt, subtracting bank reserves held at the Fed in exchange for new bills and bonds, may still test the resilience of some smaller institutions. As their reserves decline, some banks may find themselves short on cash, while investors and others may be unwilling to lend to those institutions given recent concerns about some corners of the industry. They look upset.
That could leave some banks dependent on another Fed facility, set up at the height of this year’s banking turmoil, to provide emergency funding to deposit-taking institutions at a relatively high cost.
“You could see one or two or three banks get caught unprepared and suffer the consequences, starting a daisy chain of fear that could ripple through the system and cause trouble,” said Mr. Goldberg of TD Securities. can produce.”
