As the U.S. Treasury prepares to launch a colossal $1 trillion borrowing initiative, anxiety levels are rising among banking institutions.
The flurry of borrowing activity, scheduled in the aftermath of the recently concluded debt ceiling standoff, is predicted to heap more pressure on an already strained banking system, according to traders and market analysts.
Enormous Issuance Forecasted to Elevate Yields
The Treasury department’s primary objective with the forthcoming borrowing spree is to restore its cash balance, which recently plunged to a low unseen since 2017.
Projections by JPMorgan suggest that the U.S. will need to borrow approximately $1.1 trillion in short-term Treasury bills by the close of 2023. In fact, the next four months alone are expected to see a staggering $850 billion in net bill issuance.
Anxiety within financial circles stems from fears that the enormous scale of the upcoming issuance could drive up yields on government debt, thereby depleting bank deposits.
Gennadiy Goldberg, a strategist at TD Securities, stated that the upcoming surge in Treasury bill issuance would be the largest in history, aside from extraordinary times of crisis like the financial meltdown of 2008 and the global pandemic in 2020.
Adding to the concern is the realization that yields have already started rising in anticipation of the increased supply.
Gregory Peters, co-chief investment officer of PGIM Fixed Income, noted that the shift in yields puts further strain on U.S. bank deposits, which have already diminished this year due to rising interest rates and a string of regional lender failures.
The upward yield trajectory and ongoing deposit outflow might force banks to increase interest rates on savings accounts, a move that could hit smaller lenders particularly hard.
Doug Spratley, head of the cash management team at T Rowe Price, agreed that the Treasury’s return to borrowing could potentially exacerbate existing stresses on the banking system.
Impending Market Turbulence?
This financial strain comes at a time when the Federal Reserve is already reducing its bond holdings.
Torsten Slok, chief economist at Apollo Global Management, warned that the combination of a significant budget deficit, quantitative tightening, and a potential deluge of Treasury bill issuance could spell turbulence in the Treasury market in the months to come.
Interestingly, investors have increasingly shifted to money market funds that invest in corporate and sovereign debt.
Despite the allure of Treasury bills, these funds are unlikely to purchase the entirety of the impending supply, primarily due to the comparably attractive risk-free return they currently receive on overnight funds parked with the Federal Reserve.
Future monetary policy expectations also play a role in investors’ decisions. If investors anticipate continued monetary tightening by the Federal Reserve, they are likely to prefer keeping their cash with the central bank overnight instead of purchasing Treasury bills.
Notably, current figures indicate about $2.2 trillion a night is deposited into the Fed’s overnight reverse repurchase agreement facility, largely by money market funds.
Looking ahead, as U.S. Treasury gears up to enact its ambitious borrowing plan, banking institutions find themselves bracing for the impact.
The potential yield fluctuations and heightened pressure on deposits, coupled with the recent robust employment figures, suggest that the appetite for government debt at current rates may diminish further.