The imminent return of the federal government’s debt ceiling is causing agita among money-market traders once again.
Conventional wisdom holds that the risk that Uncle Sam might default by missing a payment on a bill or two is next to nothing.
Nevertheless, investors are wondering if and how the Treasury can slash its giant cash pile to the level the department has indicated would be consistent with its policies and the 2019 act that suspended the limit.
And they’re concerned about the impact that any such moves could have on short-term funding markets, which underpin much of the global financial architecture.
By Dave Allen for Discount Gold & Silver
The imminent return of the federal government’s debt ceiling is causing agita among money-market traders once again.
Conventional wisdom holds that the risk that Uncle Sam might default by missing a payment on a bill or two is next to nothing.
Nevertheless, investors are wondering if and how the Treasury can slash its giant cash pile to the level the department has indicated would be consistent with its policies and the 2019 act that suspended the limit.
And they’re concerned about the impact that any such moves could have on short-term funding markets, which underpin much of the global financial architecture.
$450 Billion Seems to be the Number
The Treasury Department has indicated it would reduce its cash balance to $450 billion by July 31st, when the debt cap’s suspension ends.
That’s to prevent the Treasury from building up a cushion ahead of another debt ceiling suspension.
But it’s unclear whether the government is on track to reach its target from a current balance of $700 billion — or what will happen if it fails to do so.
Indeed, projections by financial research firm Wrightson ICAP indicate that the cash balance will be above $450 billion at the end the month.
One analyst there said, “With the little time that is left, something has to give.
Either they just aren’t going to get down to $450 billion, or they will have to accelerate outflows of pandemic-relief funding or otherwise do a very severe bill paydown.
“And if they do have this almost bill-issuance cliff, you will get further downward pressure on bill rates.”
(Bill paydowns, by the way, are when the government sells less debt than what’s maturing, thus reducing the amount in circulation.)
Yellen’s Getting Antsy
Things are getting antsy enough that Treasury Secretary Janet Yellen warned Congress today that her department will need to embark on “extraordinary measures” on August 2nd to prevent the government from defaulting if lawmakers can’t strike a deal to raise or extend the debt ceiling.
Yellen put lawmakers on notice that the Treasury Department will suspend the sale of bonds at the end of July — the avenue the government uses to finance its debt obligations.
Yellen’s reference to extraordinary measures are a temporary fix that allows the secretary to tap additional government accounts for a period of a few weeks.
Yellen wrote Speaker of the House Nancy Pelosi, “The period of time that extraordinary measures may last is subject to considerable uncertainty due to a variety of factors, including the challenges of forecasting the payments and receipts of the U.S. government months into the future…”
The message between the Treasury secretary and the House speaker is an official requirement should the nation’s outstanding debt close in on its statutory limit.
While the extraordinary measures have been deployed in the past to prevent a default, it’s unclear how long Yellen’s emergency capital will last in the face of unprecedented stimulus efforts sparked by the pandemic.
Shrinking the Baggage Comes with Risks
Certainly, part of the excess mentioned above will be used up by spending already authorized by Congress. But flows into government coffers from tax receipts and borrowing will partially offset that.
So, the most effective way to shrink Treasury’s cash pile will be to further slash future auction sizes—at least until the ceiling has been raised or suspended again.
And the risk of calling off auctions is worsening a supply-demand imbalance that’s already pressuring yields, which in turn could threaten the Fed’s grip on key benchmarks.
For example, the Fed has already tweaked the rate it offers on its reverse repurchase agreement and a related benchmark on excess reserves to reassert some control there. But those tools aren’t indestructible.
So, even though many traders and strategists expect Congress to eventually reach a ceiling deal, there’s still a decent chance of fireworks.
What’s more, the use of extraordinary measures means a deal doesn’t have to happen before July 31st — or August 2nd.
¿Que Paso, Nuestos Amigos?
Still, even long-time, skilled veterans are said to be struggling to figure out what’s going on in Washington.
Congressional Democrats still don’t have a plan for how to raise the debt ceiling and haven’t decided whether to insert it into a fast-track budget reconciliation bill that can pass without Republican support.
Republicans themselves aren’t far behind in providing any practical answers, other than to feign renewed righteous indignation at the nation’s spiraling debt after four years of riding the spending bandwagon.
Earlier this week, Democratic senators rejected attempts by Republicans to set conditions for increasing the federal debt limit.
The Congressional Budget Office estimates that the Treasury will likely run out of cash sometime in October or November. Yellen today begged to differ.
While the back-and-forth over the debt ceiling is a familiar Washington-insider game, at least debt traders used to be able to see the trajectory of Treasury’s cash pile.
That’s much cloudier now, perplexing investors who are already dealing with a declining supply of Treasuries.
The Treasury has removed close to $800 billion of bills from the market since the beginning of the year. That reversed some of the ramp-up that drove the cash balance to a record $1.8 trillion last year.
Rates for repurchase agreements, Treasury bills and other short-term dollar instruments have traded near or below zero for most of the year.
That finally forced the Fed last month to defend its target range by lifting its administered rates. Now securities are trading around the new floor of just 0.05%.
Markets Could See Repeat of 2020 Crisis
This framework could lead banks and money-market funds to use the reverse repo program more aggressively in anticipation of a big drop in the cash balance.
And that wouldn’t be good for anyone, especially the American taxpayer.
I used to think that Congress should have the debt ceiling automatically increase each year in line with actual revenues collected and actual expenses incurred.
But the real work of our representatives and senators should be on the front end of annual budgeting, not on the back end.
Washington’s current practice is no way to conduct the people’s business, and now our national debt is out of control, regardless of historic low interest rates.