Debt-Ceiling Negotiations Affect Financial Markets
Treasury Scrambles to Replenish Cash
The debt-ceiling negotiations may have come to an end, but the financial markets will feel their impact for months to come. To avoid disaster, the Treasury depleted its cash holdings over the past six months, reaching the point where it had almost nothing left. This leaves the Treasury with the daunting task of replenishing its cash reserves, which puts the economy at risk.
At the start of June, the Treasury general account dipped to $23 billion, which pales in comparison to the amount of daily net spending. Usually, the Treasury keeps the account balance at a minimum of $500 billion, enough to cover a week of cash outflows. To rebuild its buffers, it will have to sell bills and bonds, predominantly the former because it is easier to raise cash via short-term debt sales, for which it will need to issue more than $1 trillion in bills over the next three months.
Concerns Over Debt Sales
The question on everyone’s mind is where the money will come from. Debt sales could drain liquidity from other asset markets, starting with money-market funds, which currently holds more than $5 trillion in investments. Ideally, these funds could take most of the new bills by cutting the cash they place at the Federal Reserve. The Government will have to offer higher coupon rates than the current 5.05% yield on reverse repos, which could result in higher funding costs for regional banks. This is an unattractive prospect because regional banks are already strained.
Investors as the Biggest Buyers of Bills
Investors such as firms and pension funds may end up buying most of the bills. This could result in these investors moving their money out of deposits and into Treasuries, reducing the financial system’s bank reserves level. Currently, banks are holding excess reserves of around $3 trillion, which could easily fall to $2.5 trillion, indicating reserve scarcity.
Whether money-market funds buy more bills or not, the Treasury’s surge of issuance will increase market anxiety and volatility, increasing the risk of breaking something. For the latest news and analysis on economics, finance, and markets, subscribe to our weekly newsletter, Money Talks, exclusively for our subscribers.