Traders and analysts expect $1 trillion in US government borrowing will increase the strain on the country’s banking system as Washington returns to markets after the debt ceiling fight.
With that dispute settled – which previously prevented the US from increasing its borrowing – the Treasury will look to rebuild its cash balance, which last week hit its lowest level since 2017.
JPMorgan estimates that Washington will need to issue $1.1 trillion in short-term government debt by the end of 2023, with $850 billion in net Treasury bill issuance over the next four months.
A key concern expressed by analysts was that the sheer volume of new issuance would push up government bond yields and pull cash from bank deposits.
“Everyone knows the tide is coming,” said Gennadiy Goldberg, strategist at TD Securities. “Yields will increase because of this flood. Government bonds will continue to get cheaper. And that will put pressure on the banks.”
He said he expects the largest surge in Treasury bill issuance in history barring crises like the 2008 financial crisis and the 2020 pandemic. Analysts said the notes would have maturities ranging from a few days to a year.
The Treasury announced guidance on Wednesday and said it aims to bring its cash balances back to normal levels by September. JPMorgan said the announcement is roughly in line with its overall estimates. The Treasury also said it would “carefully monitor market conditions and adjust its issuance plans as necessary.”
Yields have already started to rise in anticipation of the greater supply, added Gregory Peters, co-chief investment officer at PGIM Fixed Income.
This shift adds pressure on US bank deposits, which have already fallen this year, as rising interest rates and the default of regional lenders have prompted customers to seek higher-yielding alternatives.
Further deposit flight and rising 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 yields could force banks to raise their deposit rates,” Peters said.
Doug Spratley, head of T Rowe Price’s cash management team, agreed that the Treasury’s return to borrowing “could add to the already existing strains in 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 bonds.
“We have a significant budget deficit. We still have quantitative tightening. If we also have a spate of T-bill issuance, we are likely to see turbulence in the treasury market in the coming months,” said Torsten Slok, chief economist at Apollo Global Management.
After the bank failures this spring, bank customers have already switched to money market funds that invest in corporate and government bonds.
According to the Investment Company Institute, an industry group, the balance of funds in money market accounts hit a record $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 government bonds, they’re unlikely to buy up all of the supply, analysts say.
This is largely because money market funds are already earning a generous risk-free rate of return — currently 5.05 percent annualized — on overnight money left with the Fed. This is only slightly below the 5.2 percent of the comparable interest rate on government bonds, which carries a higher risk.
Currently, about $2.2 trillion is invested into the Fed’s overnight repurchase agreement (RRP) facility each night, much of it from money market funds.
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That money could be used to buy government bonds if they offered yields significantly higher than the Fed’s facility, analysts said. However, the RRP rate changes with interest rates. So if investors expect the Fed to tighten further, they are likely to park their money overnight at the central bank rather than buy notes.
“While [money market funds] With RRP access, some T-Bills could be bought on margin. We think this is likely to be small compared to other types of investors [such as corporations, bond funds without access to the RRP facility and foreign buyers]’ wrote Jay Barry, co-head of rates strategy at JPMorgan, in a note.
Last week’s hard-hitting May payrolls added to the pressure by boosting investor expectations for more rate hikes ahead – which could reduce demand for government bonds at current interest rates.