2023-05-31
Lawmakers and the White House appear set to avert a calamitous U.S. government default, but stock-market investors need to be aware that what comes next could still make for a bumpy ride.
“Some time in the next several days, markets will trade their last bit of angst over raising the debt ceiling for what was always going to be the real problem — handling the massive fundraise by Treasury,” said Steven Blitz, chief U.S. economist at TS Lombard, in a Wednesday note warning of a “potent liquidity squeeze” ahead.
For weeks, analysts have been sounding the alarm over the potential for a resolution of the debt-ceiling standoff to lead to a sudden drain in market liquidity.A debt-ceiling deal will spark a new worry: Who will buy the deluge of Treasury bills?
Here’s the situation: The Treasury has spent 2023 maneuvering to keep the U.S. government below its $31.4 trillion debt ceiling. As a result, the Treasury General Account — think of it as the U.S. government’s checking account at the Federal Reserve — has been drawn down from around $580 billion at the beginning of the year to around $58 billion as of May 26.
Once a debt-ceiling deal is signed into law by President Joe Biden, the Treasury Department will move to fill that account back up. That means hitting the market with a deluge of short-term Treasury bills.
Treasury bills are debt issued by the U.S. government that mature in four to 52 weeks. New bill issuance could reach about $1.4 trillion through the end of 2023, with roughly $1 trillion flooding the market before the end of August, according to an estimate from BofA Global strategists. That would be about five times the supply of an average three-month stretch in years before the pandemic.
Strategists at Goldman Sachs have forecast up to $700 billion of bill issuance over roughly two months, once the borrowing limit is increased.
That could deplete bank reserves as depositors move money into safe, higher-yielding government debt.
Of course there’s nothing new under the sun when it comes to the debt ceiling. Past showdowns have forced Treasury to make similar replenishments. But there’s a twist, Blitz said, in that market participants have never dealt with one quite this size at the same time the Fed was also shrinking its balance sheet.
In an effort known as quantitative easing, the Fed massively grew its balance sheet by buying bonds and mortgage-backed securities in the wake of the financial crisis in 2008 and again after the start of the COVID-19 pandemic in 2020. It began shrinking its portfolio last year, a process dubbed quantitative tightening, withdrawing liquidity from the financial system.
Quantitative tightening, or QT, in 2018 and 2019 was blamed in part for market declines.
Blitz argued that the Fed’s “own angst over creating recession, QT’s days are surely numbered — or at least put on pause,” he said, along with rate hikes.
Meanwhile, the T-bill issuance will see the Treasury Department flip from adding liquidity to the economy over the past five months to a big drawdown — “the kind of shift that can push a teetering economy into recession,” Blitz said.
In the past five months, the Treasury General Account balance dropped by around $360 billion in actual, rather than annualized, dollars, Blitz noted. That means that $360 billion was spent over that period that was neither taxed nor borrowed, amounting to 3.3% of five months of nominal gross domestic product. That helps explain why growth seemed so “resilient,” he said.
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If the Treasury Department raises $650 billion to put on deposit at the Fed in the next three months, it would amount to a drain equal to 9.8% of three months of nominal GDP, Blitz wrote. “There are, of course, a whole lot of ‘other things being equal’ in this math, but the switch from add to drain is meaningful,” he said.
For investors, much will depend “on whether Treasury will bull its way through the markets to raise what’s needed in the shortest amount of time to rebuild the TGA and its finances more broadly, and how will the Fed react if Treasury does,” Blitz wrote.
Indeed, some observers question whether the shift will move markets much at all. George Saravelos, global head of FX research at Deutsche Bank, argued that the four largest TGA rebuilds over the last two decades have had a minimal market impact.
And it isn’t clear how much the coming rebuild will end up withdrawing excess liquidity from the banking system, he wrote. Much will depend on who actually ends up buying the T-bills.
If money-market funds rotate their holdings away from the Fed’s overnight reverse repurchase facility (which also drains liquidity) the net liquidity effect will be neutral, he wrote.