The United States narrowly avoided a default when President Biden signed a bill on Saturday authorizing the Treasury Department, which was dangerously close to running out of cash, to borrow more money to pay the country’s bills.
Now the Treasury is starting to build up its reserves, and the coming credit crunch could bring complications that will shake the economy.
According to estimates from multiple banks, the government is expected to borrow about $1 trillion by the end of September. That steady state of borrowing will pull cash from banks and other lenders into Treasury bills, drawing money out of the financial system and adding pressure to already stressed regional lenders.
To entice investors to lend such huge amounts to the government, the Treasury faces rising interest charges. Given the number of other financial assets tied to government bond yields, higher borrowing costs for the government also increase costs for banks, businesses and other borrowers, and could have a similar effect to roughly one or two quarter-point increases from the federal government . Reserve, analysts warn.
“The root cause is still the deadlock on the entire debt ceiling,” said Gennadiy Goldberg, interest rate strategist at TD Securities.
Some policymakers have indicated they may choose to take a break from raising rates when the central bank meets next week to assess how policies have affected the economy so far. Treasury rebuilding could undermine that decision because it would drive up borrowing costs anyway.
That, in turn, could exacerbate concerns among investors and savers that flared in the spring about how higher interest rates had eroded asset values at small and medium-sized banks.
The deluge of sovereign debt is also amplifying the effects of another of the Fed’s priorities: balance sheet contraction. The Fed has curtailed the number of new government bonds and other debt it buys, slowly draining old debt and already consuming private investors with more debt.
“The potential blow to the economy once Treasury hits the market and sells so much debt could be extraordinary,” said Christopher Campbell, who served as assistant treasury secretary for financial institutions from 2017 to 2018. could be $1 trillion in bonds and have no impact on borrowing costs.
The treasury’s general account balance fell below $40 billion last week as lawmakers scrambled to agree on raising the country’s borrowing ceiling. Mr Biden signed legislation on Saturday suspending the $31.4 trillion debt limit until January 2025.
For months Treasury Secretary Janet L. Yellen used accounting maneuvers known as extraordinary measures to delay a default. These include suspending new investments in pension funds for postmen and civil servants.
Recovering those investments is essentially a simple accounting solution, but replenishing the government’s coffers is more complicated. The Treasury Department said Wednesday it hopes to borrow enough to rebuild its cash account to $425 billion by the end of June. It will need to borrow much more to account for planned spending, analysts said.
“The floodgates are now open,” said Mark Cabana, interest rate strategist at Bank of America.
A Treasury Department spokesman said the department carefully considered investor demand and market capacity when making debt issuance decisions. In April, Treasury officials began questioning key market players about how much they believed the market could absorb after the debt limit deadlock was resolved. The Federal Reserve Bank of New York this month asked major banks for their estimates of what they expected to happen to bank reserves and loans from certain Fed facilities in the coming months.
The spokesperson added that the department had previously managed similar situations. In particular, after a period of squabbles over the debt limit in 2019, the Treasury Department rebuilt its cash pile in the summer, contributing to factors draining reserves from the banking system and upending the market’s plumbing, causing the Fed prompted to intervene to prevent a worse situation. crisis.
One of the things the Fed did was create a repurchase agreement program, a form of financing backed by Treasury debt. That backstop could provide a safety net for banks running out of money on loans to the government, although its use was widely seen in the industry as a last resort.
A similar but opposing program, which hands out government bonds in exchange for cash, is now holding more than $2 trillion, mostly from money market funds that have struggled to find attractive, safe investments. This is seen by some analysts as money on the sidelines that could flow into the Treasury’s account as it offers more attractive interest rates on its debt, mitigating the impact of the loan boom.
But the mechanism by which the government sells its debt, whereby the Fed’s bank reserves are written off in exchange for the new bills and bonds, may still test the resilience of some smaller institutions. As their reserves dwindle, some banks may run short of cash, while investors and others may be unwilling to lend to institutions they see as trouble given recent concerns about some corners of the industry.
That could leave some banks dependent on another Fed facility, set up at the height of this year’s banking turmoil, to provide emergency funding to depository institutions at a relatively high cost.
“You may see one or two or three banks that get caught unprepared and suffer the consequences, creating a chain of fear that can permeate the system and cause problems,” said Mr. Goldberg of TD Securities.
