The Next Worry After the US Debt Ceiling Deal
With the debt deal all but confirmed, the next question is how the debt issuance could affect the currency market. The impact on yields could help explain the shift in attitude at the Fed. But it also opens up another potential risk factor that could shake up markets in the coming week.
The spending and debt ceiling deal agreed between the White House and congressional Republicans back on the Memorial Day weekend has made its way through Congress pretty much without changes. The last major hurdle was passing the Senate, where 60 votes were necessary, and Democrats only have a 51 seat majority. But the bill passed comfortably with nearly a two-thirds majority. President Biden is expected to sign it into law today, meaning that the Treasury could move to start issuing debt again as soon as Monday.
The debt problem is still around
The US hit the debt ceiling back on January 19, which means that the US Treasury couldn’t not increase its debt holdings since then. It could continue to sell bonds, bills and notes as part of its regular operations of rolling over debt. But, the total amount of Treasuries has not increased since then.
Meanwhile, the Fed continued to raise rates, there was the banking crisis which caused the Fed to reverse a substantial amount of its QT, and economic worries have built up. The lack of new debt of that period has understandably affected the dynamics of the bond market. That, in turn, affects the price of the dollar, since bond yields (and their expected trajectory) is one of the largest drivers of cash flow into and out of the dollar.
How much are we talking about?
The US Treasury has made due with the amount of cash that it already had in the Treasury General Account (which is pretty much the equivalent of the Treasury’s current account). Closing in on the June 1, then later June 5th deadline, the Treasury has made a series of accounting moves that allow it to maintain payments without increasing the amount of debt it holds.
All told, it’s estimated that the US Treasury has over $700B fewer funds now than it did back on January 19. Those funds will have to be replaced with the issuance of new debt. Also, new obligations have come online since then, plus the cost of servicing the existing debt has increased. All told, it’s estimated that the Government will need to issue around $1.0T in new debt over the course of the next three months. Meanwhile, the Fed is expected to continue to withdraw its $90B/month in liquidity. All told, this could put a substantial amount of pressure on the bond market, potentially pushing yields much higher.
The method in the madness
How the Treasury deals with this will likely be key to maintaining market calm over the coming months, but especially next week as traders look for clarity on what the Treasury will do. In anticipation of a deal being signed, the Treasury has already scheduled a debt auction for Monday in an extraordinary measure. That auction includes debt that will mature in a single day, something that is extremely rare. The perception, it seems, is to focus on issuing short-term debt to reduce the overall cost, which could force the yield curve inversion to widen.
The actual details of the debt issuance are expected to be updated on Monday. After that, the Treasury said it would be issuing $123B in debt on Tuesday and Wednesday. Although the amounts suggest that the market could absorb the debt with little problem, any hiccups along the way could make the market nervous. Risk appetite could be hit, and the dollar could come back in demand as a safehaven.