The United States narrowly avoided default when President Biden signed legislation on Saturday that gave the Treasury Department, which was dangerously close to running out of cash, permission to borrow more money to pay the nation’s bills.
Now the Treasury is starting to build up its reserves, and the coming borrowing spree could present complications that shake the economy.
The government is expected to borrow around $1 trillion by the end of September, according to estimates from several banks. This steady state of borrowing is set to pull cash from banks and other lenders into Treasuries, draining money from the financial system and increasing pressure on already stressed regional lenders.
To attract investors to lend such huge sums to the government, the finance ministry faces rising interest costs. Given how many other financial assets are tied to the Treasury rate, higher borrowing costs for the government also raise costs for banks, companies and other borrowers and could create a similar effect to roughly a quarter point or two rate hike from the Fed. Reserve, analysts warned.
“The main driver is still pretty much the balance of the entire debt ceiling,” said Gennadiy Goldberg, interest rate strategist at TD Securities.
Some policymakers have indicated they may decide to pause rate hikes when the central bank meets next week to assess how policy has affected the economy so far. The Treasury’s cash recovery could undermine that decision because it would push borrowing costs higher regardless.
That, in turn, could add to investor and depositor fears that flared up in the spring over how higher interest rates eroded the value of assets held by small and medium-sized banks.
The deluge of government debt also amplifies the effects of the Fed’s other priority: shrinking its balance sheet. The Fed has reduced the amount of new Treasuries and other debt it buys, has slowly let old debt fall, and is now leaving more debt for private investors to digest.
“The potential hit to the economy once the Treasury moves into the market to sell such debt could be extraordinary,” said Christopher Campbell, who served as assistant secretary of the Treasury for financial institutions from 2017 to 2018. “It’s hard to imagine the Treasury going out and selling what could be $1 trillion in bonds and not having an impact on borrowing costs.”
The cash balance in the Treasury’s general account fell below $40 billion last week as lawmakers scrambled to reach an agreement to raise the state’s borrowing limit. Mr. Biden signed legislation on Saturday that suspended the $31.4 trillion debt limit until January 2025.
For months, Treasury Secretary Janet L. Yellen used accounting maneuvers known as emergency measures to delay a default. These included suspending new investments in pension funds for postal workers and civil servants.
Restoring these investments is essentially a simple accounting correction, but replenishing the state treasury is more complex. The Treasury Department said Wednesday it hopes to borrow enough to restore its cash account to $425 billion by the end of June. Analysts said it would need to borrow far more than it would meet planned spending.
“The supply floodgates are now open,” said Mark Cabana, interest rate strategist at Bank of America.
A Treasury spokesman said the ministry carefully considered investor demand and market capacity when deciding whether to issue the debt. In April, Treasury officials began asking key market players how much they thought the market could absorb after the debt limit problem was resolved. Federal Reserve Bank of New York this month asked the big banks for their estimates of what they expect will happen to bank reserves and borrowing from certain Fed facilities in the coming months.
The spokesman added that the department had dealt with similar situations before. Notably, after a spate of debt limit disputes in 2019, the Treasury rebuilt its cash holdings over the summer, adding to the factors that drained reserves from the banking system and reversed market conditions, prompting the Fed to intervene to avert a worse situation. crisis.
One of the things the Fed did was create a program for repurchase agreements, which is a form of financing with Treasury debt posted as collateral. The backstop could provide a safety net for banks short of cash from loans to the government, although its use was widely seen as a last resort in the industry.
A similar but opposite program, which provides government collateral in exchange for cash, now holds more than $2 trillion, mostly from money market funds that are struggling to find attractive and safe investments. Some analysts see this as margin money that could flow into the Treasury’s account as it offers more attractive interest rates on its debt, reducing the impact of borrowing.
But the mechanism by which the government sells its debt and writes down bank reserves held at the Fed in exchange for new bills and bonds could still test the resilience of some smaller institutions. As their reserves dwindle, some banks may find themselves strapped for cash, while investors and others may be reluctant to lend to institutions they see as troubled, given recent concerns about some corners of the industry.
That could leave some banks dependent on the Fed’s additional facility, set up at the height of this year’s banking turmoil, to provide emergency funding to deposit-taking institutions at a relatively high cost.
“You can see one or two or three banks caught off guard and suffer the consequences, which starts a daisy chain of fear that can permeate the system and cause trouble,” said TD Securities’ Mr. Goldberg.