MNI INTERVIEW: US Treasury Buffer To Ease Reverse Repo Takeup

The U.S. Treasury may keep its cash balance at a considerably higher level than previously forecast by the end of July so as to build a larger buffer for potentially dragged out debt-ceiling negotiations in Congress, putting less downward pressure on money market rates, former New York Fed economist Christopher Russo told MNI.

Treasury is likely to try to smooth the bumpy ride past the Aug. 1 debt ceiling deadline by keeping borrowing on a steadier path and only drawing down its cash balance to around USD600 billion at month-end from USD734 billion now, some USD150 billion higher than it previously forecast, he said.

That means in the near-term there could be less downward pressure on money market rates and potentially less take-up at the Fed's reverse repurchase facility than there would otherwise have been, he said.

"If the Treasury General Account needs to be elevated going into July 31, the Treasury won't take extreme action to cut down to USD450 billion," said Russo, who led the NY Fed Desk's forecasts of Treasury's cash balance during the 2019 debt limit episode. "I'm not anticipating extreme action in the TGA and as a consequence of that prediction I'm not expecting any extreme action on the bill supply."

In the latest quarterly refunding plan released early May, the finance department surprised markets by targeting a higher cash balance of around USD450 billion at the end of July, before a two-year debt ceiling suspension expires, but said the estimate could change based on expected outflows.

U.S. government revenues have come in stronger than expected, helping to keep the TGA elevated, Russo said, but that may not lead to larger bill paydowns. The nonpartisan Congressional Budget Office recently revised its fiscal year 2021 deficit projection down to USD3.0 trillion from USD3.4 trillion and Treasury officials have been vocal in urging lawmakers to act sooner rather than later to address the debt ceiling.

PRECAUTIONARY MEASURES

The debt ceiling was last suspended for two years in July 2019. If Congress doesn't raise or suspend the limit on U.S. borrowing this month, then Treasury will be forced to deploy extraordinary measures to keep paying its debts. Lawmakers recently renewed threats that would hold out raising the debt ceiling in exchange for concessions on other matters.

Operating in the Treasury's favor this year is revised language in the 2019 law that suspended the debt limit then, Russo said. "That language no longer explicitly called for Treasury to reduce its cash balances down to the level at which they were at when the debt limit was suspended," he said. "Unlike previous go arounds, the Treasury didn't have to reduce its cash balances down to extraordinarily low levels."

Treasury bill paydowns, or when the government sells less debt than is maturing, thus reducing what's in circulation, will continue at a slower pace than earlier this year but net-positive bill issuance appears unlikely anytime soon, said Russo, now at the Mercatus Center at George Mason University.

Bill rates have been hovering at low levels as Treasury cut bills supply by more than USD680 billion during the first half of 2021 to bring its cash balance down. The Federal Reserve's asset purchases have also deluged the system, forcing the central bank to lift key administered rates last month to help better control the fed funds rate.

The Treasury's slower reduction of the TGA would still increase reserves in the banking system, which have flowed into the reverse repo market, Russo added, and usage of the Fed's overnight RRP facility will likely stay at record highs through most of 2022.