Navigating through the unnerving corridors of the US debt-ceiling impasse, we are confronted not only with the dreadful specter of a default but also an underemphasized aftermath of a possible resolution.
Agreement seems imminent among the denizens of Wall Street, who anticipate that lawmakers will pull through with a solution that successfully fends off a catastrophic debt default. Yet, one must not ignore the ensuing tremors this might send across the economy, resulting from the Treasury’s urgent resumption of borrowing.
Our present discourse calls attention to a foreseeable liquidity exodus as the Treasury, in its urgency to replenish its depleted cash reserves, triggers a deluge of Treasury-bill sales. The enormous surge, potentially exceeding $1 trillion by the end of Q3, could effectively withdraw liquidity from the banking sector, escalating short-term funding rates and tightening the economic noose at the brink of a recession. It’s akin to a quarter-point interest-rate hike, in the reckoning of Bank of America Corp.
Borrowing costs have already been emboldened by the Federal Reserve’s most rigorous tightening spree in decades, progressively blunting economic growth. The Treasury’s prospective cash-replenishing rush could instigate a profound slash in bank reserves, raising fears of a deep, sudden liquidity drain.
Post-debt-ceiling resolution, we anticipate the US cash stockpile, the Treasury General Account, to skyrocket to $550 billion by the end of June from its current $95 billion, eventually peaking at $600 billion three months later. This revival could influence liquidity across financial systems since the Treasury, in essence, pulls cash out of the private sector and stores it in the Federal Reserve.
However, the dynamics become more convoluted considering the Fed’s reverse repurchase agreement facility, or the RRP, currently over $2 trillion. If the Treasury account swells and RRPs diminish, the strain on reserves is mitigated. Yet, if money funds’ propensity to keep cash in RRPs endures, a notable drain in bank reserves might be unavoidable.
The landscape further contorts as central banks globally have been depleting liquidity via aggressive tightening campaigns and balance sheet unwinding efforts.
Looking ahead, we foresee the Treasury’s cash balance augmentation, the Fed’s quantitative tightening, and the repercussions of higher policy rates potentially weighing on risk assets as well as the broader economy. Post-resolution, the ensuing $1 trillion T-Bill torrent could stir a tempest in our already stormy financial seas, leaving us to question – is this the calm before the storm, or are we just shifting from one tempest to another?
