US Treasury’s $1 trillion lending campaign set to strain banks

A $1 trillion borrowing spree by the US government is set to increase pressure on the country’s banking system, traders and analysts say, as Washington returns to markets after a debt-limit battle.

Following the resolution of that dispute – which previously prevented the US from increasing its borrowing – the Treasury Department will seek to rebuild its cash balance, which last week fell to its lowest level since 2017.

JPMorgan estimates Washington will need to borrow $1.1tn in short-dated Treasury bills through the end of 2023, with $850bn in net bill issuance over the next four months.

A major concern expressed by analysts was that the sheer volume of new issuance would push up the yield on government debt, sucking up cash from bank deposits.

“Everyone knows the flood is coming,” said Gennady Goldberg, a strategist at TD Securities. “The yield will be high because of this flood. Treasury bills will be cheaper. And this will put pressure on the banks.

He said he was expecting the biggest increase in Treasury bill issuance in history, apart from the 2008 financial meltdown and the pandemic in 2020. Analysts said the maturities of the bills would range from a few days to a year.

treasury department provided guidance on Wednesday, saying it aims to return its cash balances to normal levels by September. JP Morgan said the announcement was broadly in line with its overall estimates. The Treasury also said it would “carefully monitor market conditions and adjust its issuance plan as appropriate”.

Gregory Peters, co-chief investment officer at PGIM Fixed Income, said yields had already started rising in anticipation of increased supply.

The change adds to pressure on US bank deposits, which have already fallen this year as rising interest rates and the failure of regional lenders sent customers looking for higher-yielding alternatives.

Further deposit flight and a rise in yields could prompt banks to offer higher interest rates on savings accounts, which could be costly, especially for smaller lenders.

“The rise in yields could force banks to raise their deposit rates,” Peters said.

Doug Spratly, head of the cash management team at T Rowe Price, agreed that a return to Treasury borrowing “could exacerbate the stresses that were already on the banking system”.

The supply shock came when the Fed was already offloading its bond holdings, unlike in the recent past, when it was a big buyer of government debt.

“We are running a significant budget deficit. We still have the quantitative criterion. If we also have a flood of T-bill issuances, we are likely to see Treasury market turbulence in the coming months,” said Torsten Slok, chief economist at Apollo Global Management.

The bank’s clients have already shifted heavily to money market funds that invest in corporate and sovereign debt after the bank’s failures this spring.

According to data from the Investment Company Institute, an industry group, the stock of money in money market accounts reached a record $5.4tn in May – up from $4.8tn at the start of the year.

Analysts said that although money market funds are typically big buyers of Treasury bills, they are unlikely to buy the entire supply.

That’s largely because money market funds already receive a generous risk-free return — currently 5.05 percent annually — on overnight funds with the Fed. This is only slightly less than the 5.2 percent available at the comparable Treasury rate, which carries more risk.

Currently, roughly $2.2tn per night is pouring into the Fed’s overnight reverse repurchase agreement facility (RRP), much of it from money market funds.

Analysts said that cash could be redeployed to buy Treasury bills if they offered significantly higher returns than the Fed’s facility. But the RRP rate moves with the interest rates. So if investors expect the Fed to continue tightening monetary policy, they are likely to keep their cash with the central bank overnight rather than buy bills.

“While (money market funds) may purchase some T-bills on margin with RRP access, we believe this is likely relative to other investor types (such as corporations, bond funds without access to the RRP facility, and foreign buyers).” Will be smaller, Jay Barry, co-head of interest rate strategy at JPMorgan, wrote in a note.

Last week’s blockbuster headline employment data for May added to the pressure by raising investor expectations that further rate rises are on the way – which could reduce appetite for government debt at current rates.