Evening Brief – 06.02.23
As we noted on Thursday, the political spectacle surrounding the debt limit agreement has been postponed until after the 2024 election because of a last-minute compromise to temporarily suspend the US federal debt ceiling until 2025. However, the narrative has not yet reached its conclusion for investors.
In tonight’s Evening Brief we discuss stage two – Treasury issuance.
The need for the Treasury to deposit more funds into the Treasury account, which manages the day-to-day operations involving public funds, is a potential source of concern.
Issuing Treasury debt reduces available liquidity. Amid the threat of hitting the debt ceiling, the Treasury Department reduced its cash reserves to just $39 billion, which is approximately $540 billion below its aim of having enough cash to cover one week’s worth of expenditures.
For the Treasury to replenish the account, it may have to issue Treasury bills in the amount of $730 billion over the next three months and around $1.25 trillion over the course of the rest of the year, according to government estimates.
The debt ceiling has been temporarily raised, enabling the Treasury to rapidly issue new debt not only to make payments but also to replenish its cash reserves. This will result in a permanent liquidity outflow from the private sector, or one that will persist until the next debt ceiling crisis.
The drop in cash reserves held by private companies could add to the already mounting upward pressure on the US dollar and weigh on asset values. The combination of new issuance and less money available to buy them is likely to have a particularly negative impact on US Treasuries, which might put banks in jeopardy.
A selloff in US Treasuries will add to the unrealized losses on bank balance sheets, which might frighten depositors and force banks to seek more capital if they don’t act quickly. In addition, the action by the Treasury to raise funds could draw deposits away from the banking system and reduce bank reserves, which could lead to liquidity issues in the financial system.
We will discuss the third and final stage in Monday’s Evening Brief.