On June 6, local time, US President Biden signed a bill on the federal government's debt ceiling and budget at the White House, ending the recent uncertainty surrounding the possibility of the United States falling into a government debt default. But the ensuing wave of U.S. Treasury bills could trigger a drying up of liquidity in financial markets.
As the U.S. Congress continues to tug over raising the debt ceiling, the U.S. Treasury is rapidly depleting its cash balance in the Fed's general account (TGA). TGA cash balances have fallen to $6.2 billion, the lowest level since October 228, according to data disclosed by the U.S. Treasury Department on June 92. To rebuild the coffers, the U.S. Treasury will begin to borrow heavily.
On the Fed's balance sheet, the TGA is a liability, like banknotes, coins, and bank reserves. But the Fed's liabilities must match its assets, so the TGA account balance must increase at the same time as the bank reserves decrease, and vice versa. Against the backdrop of the Fed's interest rate hike and balance sheet reduction, several US banks have collapsed one after another, and the US financial system has already shown signs of stress. If the US Treasury issues bonds on a large scale, or returns a large amount of liquidity from the financial markets, it will make the already stressed financial system even worse.
"Replenishing the treasury's cash balances and financing the broader deficit will reduce the supply of bank reserves (i.e., liquidity withdrawal), depending on three factors: IMF behavior, balance sheet capacity and yield." Joseph Abate, a currency market strategist at Barclays, told First Financial Reporter: "However, the outlook is particularly bleak as the demand for reserves is also increasing. ”
"Borrowing more than trillion dollars during the year"
Abarth told First Finance and Economics that Barclays estimates that by the end of this year, the US Treasury's borrowing scale may be between 1.2 trillion ~ $1.4 trillion, and the impact on liquidity will largely depend on who will eventually buy these short-term Treasury bonds, banks, money market funds or non-bank institutions.
At present, banks' interest in treasury bills is limited, as the latter are unlikely to provide a yield that can compete with what the banks' own reserves can obtain. But even if banks don't participate in U.S. Treasury auctions, customers switching their deposits to U.S. Treasuries could wreak havoc.
Citi simulated the historical event of a $12 billion decline in bank reserves over a 5000-week period to estimate what would happen in the coming months. Dirk Weller, the bank's head of global markets macro strategy, said: "The decline in bank reserves is a classic headwind. "In contrast, the most optimistic scenario is that supply is dominated by money market mutual funds. Industry insiders analyzed that in this case, the level of bank reserves may not be affected. However, money market funds, historically the main buyers of U.S. Treasuries, have recently retreated in favor of the higher yields offered by the Fed's reverse repo agreement instrument.
If non-banks are the main buyers of new bond issuances, they are expected to free up funds to purchase assets by clearing bank deposits, exacerbating capital flight from the banking sector.
Once again, a cloud of liquidity hangs over the market
For now, the news that the US has avoided a default has relieved the market, diverting attention from the aftershocks of liquidity. Meanwhile, investors are excited about the prospect of AI, putting the S&P 500 on the brink of a bull market after three straight weeks of gains.
JPMorgan strategist Nicola Panigilzoglu estimates that the large inflow of money into the US Treasury market will exacerbate the impact of quantitative tightening (QT) on stocks and bonds, dragging down the total performance of the stock and bond markets this year by nearly 5%. Similarly, Citigroup strategists believe that after such a massive liquidity curtailment, the median decline of the S&P 500 in two months could reach 5.4%, while the spread on high-yield bonds could swing by 37 basis points.
Analysts believe that against the backdrop of an already continuous contraction of the broad money supply (M2), financial markets will set off an indiscriminate sell-off. JPMorgan estimates that U.S. M2 will fall $2023.25 trillion from about $1 trillion in early 1.
Panigilzoglu said: "This is a very large liquidity drain. We rarely see such a thing. You will only see this contraction in a disaster as serious as the Lehman crisis. ”
JPMorgan estimates that this trend, combined with Fed tightening, will see M2 decline at an annual rate of 6 percent, in stark contrast to the positive growth rate for most of the past 10 years.
"Now is not a good time to hold the S&P 500," Weller said. "When bank reserves fall significantly, stock markets tend to fall, while credit spreads widen, with riskier assets bearing the brunt.
Barclays said that while artificial intelligence has driven the rally in the stock market, the allocation to U.S. stocks is generally neutral, with mutual funds and retail investors standing still.
Ulrich Urbahn, head of multi-asset strategy at Berenberg, said: "We believe that US stocks will fall sharply and volatility will not surge as liquidity dries up. We face bad insider market factors, negative leading indicators, and reduced liquidity, which are not good for the stock market. ”