Market fears about the possibility of a historic US default on its debts loom on the horizon, but it seems to be the least risk of what the market is discussing about the consequences of reaching a deal regarding the debt ceiling crisis.
Many on Wall Street predict that lawmakers will eventually reach a deal, potentially avoiding a devastating debt default, even if it seems a long way off. But that doesn’t mean the economy won’t be hurt, not only from the painful standoff, but also as a result of the Treasury’s efforts to get back to business as usual once it can ramp up borrowing.
Ari Bergman, whose firm specializes in hard-to-manage risks, says investors should hedge the fallout from Washington’s decision.
And the veteran expert in the market believes that the Treasury will need to intensify its issuances to replenish its dwindling cash stock to maintain its ability to pay its obligations, through a flood of treasury bill sales, according to what he said to Bloomberg, and Al Arabiya.net viewed it.
Supply is expected to exceed $1 trillion by the end of the third quarter, and the supply explosion will quickly drain liquidity from the banking sector, raise short-term funding rates, and completely tighten the screws on the US economy which is on the cusp of recession. By Bank of America Corp.’s estimate, it would have the same economic impact as a quarter-point rate hike.
This comes as rising borrowing costs in the wake of the Fed’s most aggressive tightening cycle in decades have inflicted heavy losses on some companies and are slowly hampering economic growth. Against this backdrop, Bergman is particularly wary of an eventual move by the Treasury Department to rebuild liquidity, and sees the potential for a massive drop in banks’ reserves.
“My concern is that when the debt ceiling crisis is resolved — and I believe it will — you will have a very deep and abrupt drain on liquidity,” said Bergman, founder of Penso Advisors in New York. risk, such as stocks and credit.
The upshot is that even after Washington has weathered the latest standoff, the dynamics of the Treasury’s monetary balance, the Fed’s portfolio management program known as quantitative tightening, and the pain of rising interest rates will all affect risky assets as well as the economy.
After the debt ceiling is settled, the US cash stock – the Treasury’s general account – should rise to $550 billion at the end of June from the current level of about $95 billion – and reach $600 billion three months later, according to the latest US administration estimates.
When the Treasury issues more bonds than it technically needs over a given period, its account swells—pulling cash from the private sector and storing it in the Treasury account at the Federal Reserve.
Another important piece of the puzzle is the Fed’s reverse repo facility – dubbed the RRP – whereby money market funds stockpile cash with the central bank overnight at a rate of just over 5%.
Another puzzle
This program—currently over $2 trillion—is also a responsibility of the Federal Reserve. So if the treasury account increases, but the suggested hash rate decreases, the drain on reserves is less.
But Citigroup’s global markets analyst, Matt King, believes that the tendency for cash funds to hold cash in the “RRP” will likely continue, which could mean a significant drain on banks’ reserves when treasury cash jumps.
It will come as major central banks are already siphoning off liquidity through aggressive tightening campaigns and efforts to clean up their balance sheets.
For TD Securities’ head of global rate strategy, Priya Misra, the concern is that reserves will become scarce, upsetting the funding markets that are at the heart of many trades on Wall Street.
For Misra, such scarcity is “very important because it raises buyback rates”. High repo rates usually lead to a large proportion of the risk. If I’m in a hedge fund, my entire business model is borrowing money. And what will happen is not only that the price will go up, but that I may not be willing to lend you.
This kind of effect on financing markets is basically what was seen after the 2017-2018 debt ceiling episode – when the Treasury Department issued $500 billion in bonds in about 6 weeks.
Of course, the Treasury knows that a deluge can roil the markets and fundamental traders have wondered about this in the recent cashback period. The companies encouraged the ministry to monitor the markets for potential stress, to ensure they did not restock their cash balance too quickly.
The United States remains dangerously close to the current federal debt limit of $31.4 trillion, at which point it may lose its ability to meet all repayment obligations. Treasury Secretary Janet Yellen says the defining moment – Date X – could arrive by June 1. Since mid-January, her ministry has been using so-called extraordinary measures to continue paying off debt — such as reducing benchmark bond auction sizes.
