The US Debt Cap Issue Has Widened With a Downward Trend on Short-Term Interest Rates

The US Treasury is under pressure to reduce the balance of its government deposit account (TGA) before the measures to suspend the application of the federal debt cap expire at the end of July. Furthermore, there will be an inflow of funds into the financial system, which already has a large amount of liquidity. This could further reduce short-term interest rates and bring unnecessary “distortion” to the overnight repo market.

Parliament sets a limit on the amount that the federal government can borrow to pay various debts. Once the limit is reached, the Treasury will not be able to issue any more short-term, medium-term, or long-term government bonds and will have to pay only with tax revenue. In July 2019, Congress agreed to temporarily suspend the application of debt caps until the end of July 2009. From there, the Treasury can only take “special measures” to raise funds for a few months, and if Congress does not raise the cap during this time, defaults will occur.

It’s a reduction of cash holdings as the Ministry of Finance aims to increase the TGA balance to $450 billion at the end of July. According to data from US research firm Lightson ICAP, the balance as of June 9 was $ 674 billion, well below the $ 1.8 trillion in October last year. According to analysts, the balance cannot be built up before the debt cap is restored as it is considered an action that evades the debt cap.

Even if Congress doesn’t raise the cap or extend the suspension of the cap, this balance can make up for a month or so. After that, there are some “special measures” that can be used independently for cash flow. As the Treasury withdraws more TGA, the money is often sucked into the bank’s balance sheet in the form of money market funds (MMFs). Lightson estimates that banks’ average reserve requirements in June will reach $ 3.8 trillion to $ 4 trillion.

Investors are investing in the Federal Reserve Bank of New York’s reverse repo because short-term interest rates are extremely low, and some are on the verge of falling below zero. The current applicable interest rate is zero. The reverse repo has experienced record demand from institutional investors desperately looking for short-term investment destinations, with transaction volumes reaching a record $ 535 billion on the 11th. Analysts say the size of these transactions highlights the tensions inherent in the market, which in turn puts pain on investors, depositors, and short-term markets that exchange cash.