US Treasury’s $1tn borrow drive to put pressure on banks

Analysts are worried that the new debt issuance after the fight over the debt ceiling will drive up yields, and drain cash from deposits. .A $1tn US government borrowing spree is set to increase the strain on the country’s banking system as Washington returns to the markets in the aftermath of the debt ceiling fight, traders and analysts say.

After the resolution of the dispute, which prevented the US to increase its borrowings in the past, the Treasury Department will try to rebuild its balance. Last week it hit its lowest point since 2017.

JPMorgan estimates that Washington will require $1.1tn of short-dated Treasury Bills before the end 2023. This amount is expected to be $850bn over the next 4 months.

Analysts expressed concern that the sheer amount of new debt would drive up interest rates on government bonds, causing cash to be drained from bank accounts.

Gennadiy goldberg, a strategist with TD Securities, said: “Everyone is aware that the flood will come.” This flood will cause yields to rise. Treasury bills will become cheaper. “And that will put pressure onto banks.”

He said that he expected the largest increase in Treasury bills issuance ever, except during crises like the financial meltdown of 2008 and the pandemic of 2020. Analysts predicted that the maturity of these bills would range from a few weeks to a full year.

On Wednesday, the Treasury department provided with guidance and stated that it hopes to restore its cash balances by September. JPMorgan stated that the announcement was in line with their overall estimates. Treasury said that it would also “carefully monitor the market conditions and adjust their issuance plans if necessary”.

Gregory Peters is the co-chief investment officer at PGIM Fixed Income. He said that yields have already started to rise as a result of increased supply.

This shift puts more pressure on US bank deposit, which has already dropped this year due to the increase in interest rates.

The rise in yields and further deposit flight could push banks to increase interest rates on saving accounts. This could be especially costly for smaller lenders.

Peters stated that the rise in yields may force banks to increase their deposit rates.

Doug Spratley of T Rowe Price’s cash management team agreed that Treasury’s return on borrowing could “exacerbate the stresses already placed on the banking system”.

The Fed has already begun to reduce its bond holdings. This is in stark contrast to recent years, when the Fed was a major buyer of government bonds.

“We’re running a significant budget deficit. Quantitative tightening is still in place. We will likely see turbulence on the Treasury Market in the coming months if we also have a flood in T-bills.

Following the failures of banks this spring, bank customers have already shifted heavily to money market funds which invest in corporate debt and sovereign debt.

According to the Investment Company Institute (an industry group), the stock of money in money market accounts hit a record of $5.4tn, up from $4.8tn when the year began.

Analysts said that while money markets funds typically buy large quantities of Treasury Bills, they will not likely purchase the entire supply.

Money market funds receive an already generous return on overnight funds held at the Fed. This rate is currently 5.05 percent annualised. This is just a little below the 5.2% available at the Treasury rate which carries a higher risk.

The Fed’s overnight reverse purchase agreement facility (RRP) is currently receiving about $2.2tn per night, a large portion of which comes from money market funds.

Analysts said that the cash could be used to purchase Treasury Bills if those offered returns significantly higher than the Fed facility. The RRP rate is affected by interest rates. If investors believe that the Fed will continue to tighten its monetary policy they may keep their money at the central bank rather than buy bills.

Jay Barry, JPMorgan’s co-head for interest rate strategy, wrote that “While [money-market funds] with RRP-access could buy T-bills at a margin, this is likely to be small in comparison to other investors types (such as corporations, bonds funds without access to RRP and foreign buyers]”.

The headline figures for May released last week have increased the pressure on investors by increasing their expectations of future rate increases. This could reduce appetite for government bonds at current rates.