The US Treasury’s maneuvering to prolong its borrowing authority and remain under the statutory borrowing limit in 2023 will likely mute the Federal Reserve’s efforts to tightening monetary policy at least in the near term.
(Bloomberg) — The US Treasury’s maneuvering to prolong its borrowing authority and remain under the statutory borrowing limit in 2023 will likely mute the Federal Reserve’s efforts to tightening monetary policy at least in the near term.
When the monetary authority began unwinding its holdings in 2022, concern centered on how fast and at what point reserves would become scarce and financial institutions would be forced to start borrowing in dollar funding markets, ultimately pushing the Fed to halt so-called quantitative tightening.
But now with the debt-ceiling looming, the Treasury is set to shrink its pile of cash and adjust its stock of bills to prolong its borrowing authority. That will likely keep markets relatively more flush with cash, thwarting the Fed’s efforts to drain liquidity from the system at least until an agreement is reached.
Currently, the government is roughly $78 billion away from reaching its $31.4 trillion statutory borrowing limit, although analysts doubt the government is actually at risk of defaulting until the second half of 2023 because of the extraordinary measures the Treasury usually uses to avoid exceeding the cap. Treasury Secretary Janet Yellen said Friday the department will begin taking special accounting maneuvers on Jan. 19 to avoid breaching the US debt limit, urging lawmakers to boost the ceiling to avert a devastating payments default.
At the heart of the issue is the liability side of the central bank’s balance sheet, comprised mostly of the Treasury’s cash parked at the Fed, bank reserves and balances at the overnight reverse repurchase agreement facility. Jockeying by the Treasury before and after a debt-limit resolution affects how the Fed’s balance sheet and excess liquidity drains from the markets. The Treasury General Account, or TGA, operates like the government’s checking account at the Fed. When Treasury increases its cash balance, it drains reserves from the system, and vice versa.
Strategists at Bank of America Corp. expect the Treasury’s lower cash balance to neutralize QT, with modest declines in reserves and balances in its reverse repo facility, or RRP. But after an agreement is reached on the debt limit, RRP balances are likely to plunge as Treasury ramps up bill issuance to replenish its coffers.
“QT matters not only for the total stock of privately held Treasuries the market needs to absorb, but it is also important for the distribution of Fed liabilities,” strategists Mark Cabana and Katie Craig wrote in a note to clients Friday.
Since the Fed started QT at the beginning of June, the balance sheet in aggregate has shrunk by about $405 billion. On the liability side, the TGA has dropped by roughly $456 billion and reserves have fallen by $198 billion over the same period. Those drops have been offset by an increase in the Fed’s RRP, which rose about $197 billion.
BofA strategists still expect the Fed’s balance sheet to decline by nearly $1 trillion in 2023, with most of that coming out of the RRP. Balances at the facility are roughly $2.2 trillion as money-market funds continue to park their cash due a lack of investable assets, like Treasury bills. While recent increases in supply could alleviate some of the scarcity plaguing the front end for the past two years, the post-debt limit bill surge — which analysts estimate to be around $1 trillion — should spur a migration from the Fed.
As a result, the scarcity in bank reserves many Wall Street strategists were expecting in 2023 may never materialize, according to Cabana and Craig.
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