Investors Brace For Debt Deal Bombshell

Investors Warned of Impact of Raising US Debt Ceiling

Will lawmakers reach an agreement to raise the debt ceiling and avert a potential historic default? That’s the million-dollar question as negotiations between Congress and President Joe Biden’s administration drag to the wire. But unfortunately, while expectations are high that a deal will be struck to resolve the impasse, the market is yet to factor in the impact of any agreement.

Building Treasury Account

The economy is not expected to come out unscathed with any agreement as the negotiations drag. For starters, it will take some time before businesses return to normal operating conditions, especially on the borrowing front. As a result, risk managers are already calling investors, businesses and the corporate world to start hedging the aftermath of any Washington resolution.

One of the biggest risks at stake with the Treasury looking to reach an agreement to lift the debt ceiling is that it will have to try to replenish its dwindling cash reserves that have dropped to about $95 billion. It’s the only way the department will be able to meet its growing financial obligations.

Consequently, the department will have to enter the market and engage in Treasury bill sales of well over $1 trillion to help bolster the cash reserves. The sales are expected to result in a significant drain of liquidity in the banking sector, something that could have serious ramifications amid the fragile economy fueled by the banking crisis.

Once the debt ceiling impasse is settled, the treasury account is expected to surge to $550 billion on aggressive Treasury bill sales by the end of June. It should increase by a further $600 billion three months later.

Growing Treasury Account Impact

Whenever the Treasury Department sells a significant amount of bills over a short period, its accounts swell. In return, it results in cash being pulled out of the private sector, which affects liquidity in the overall market. Consequently, analysts and economists are already warning of the potential risks posed by the Treasury accounts increasing significantly over a short period.

The race to replenish cash reserves should also result in a significant increase in short-term funding rates. A significant increase could be detrimental as it would come at a time when the benchmark rate has increased at the fastest pace in decades in the race to try and stem runaway inflation. Moreover, any further increase in interest rates could take a toll on a US economy facing slow growth.

Bank of America analysts are already signaling that an increase in short-term funding rates will have the same impact as a quarter-point interest rate hike by the Fed. Consequently, while the market has already priced in the fact that the Fed has reached the end of its monetary policy tightening, the impact of treasury bill sales is yet to be factored in.

Higher borrowing costs are the last thing the US economy needs amid slowing growth in various sectors. The increase would significantly affect companies and businesses’ ability to access cheap capital needed to fuel and accelerate economic activities.

Another piece of the puzzle that investors have to factor in with raising the debt ceiling is the Fed’s Reverse Repurchase Agreement RRP. The facility currently has over $2 trillion as money market funds continue to store funds to take advantage of the overnight rate of just over 5%. Consequently, an increase in the Treasury account without a significant drop in the RRP should result in a significant drain of bank reserves that should affect liquidity in the market further.

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