U.S. Treasury’s borrowing drive worries lenders

As the US Treasury prepares to embark on a colossal $1 trillion borrowing initiative, concerns are rising within the banking sector. Traders and market analysts predict that this surge in borrowing, which follows the recent debt ceiling standoff, will place additional strain on an already stretched banking system.

The primary objective of the Treasury department’s upcoming borrowing spree is to replenish its cash balance, which has hit a low not seen since 2017. JPMorgan projections indicate that the US will need to borrow approximately $1.1 trillion in short-term Treasury bills by the end of 2023. The next four months alone are expected to witness an astounding $850 billion in net bill issuance.

The apprehension within financial circles stems from the fear that the vast scale of the forthcoming issuance could drive up yields on government debt, thus depleting bank deposits. Gennadiy Goldberg, a strategist at TD Securities, highlighted that the surge in Treasury bill issuance to come would be the largest in history, excluding extraordinary times of crisis such as the financial meltdown of 2008 and the global pandemic in 2020.

Compounding these concerns is the realization that yields have already begun to rise in anticipation of the increased supply. Gregory Peters, co-chief investment officer of PGIM Fixed Income, noted that this shift in yields further strains US bank deposits, which have already dwindled this year due to rising interest rates and a series of regional lender failures. The upward trajectory of yields and the ongoing outflow of deposits may force banks to raise interest rates on savings accounts, potentially impacting smaller lenders disproportionately.

Doug Spratley, head of the cash management team at T Rowe Price, agreed that the Treasury’s return to borrowing could exacerbate existing pressures on the banking system. These financial strains arise 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 result in turbulence in the Treasury market in the coming months.

Interestingly, investors have increasingly turned to money market funds that invest in corporate and sovereign debt. However, despite the appeal of Treasury bills, these funds are unlikely to absorb the entire impending supply due to the relatively attractive risk-free return they currently receive on overnight funds held with the Federal Reserve. Investor decisions are also influenced by future monetary policy expectations. If investors anticipate continued tightening by the Federal Reserve, they are more inclined to keep their cash with the central bank overnight instead of purchasing Treasury bills. Notably, around $2.2 trillion is deposited into the Fed’s overnight reverse repurchase agreement facility each night, largely by money market funds.

Looking ahead, as the US Treasury prepares to implement its ambitious borrowing plan, banking institutions find themselves bracing for the impact. The potential fluctuations in yields and the heightened pressure on deposits, combined with recent robust employment figures, indicate that the demand for government debt at current rates may further diminish.