By Richard Leong
NEW YORK (Reuters) – The U.S. government may flood the bond market in the coming weeks with short-term bills to rebuild its cash stockpile that dwindled before the White House and Congress agreed on a budget deal allowing an increase in federal borrowing.
Even as an anticipated rate cut on Wednesday from the U.S. Federal Reserve would be expected to push T-bill rates lower, this spike in bill supply will likely cause interest rates in money markets to rise at least temporarily. That is because investors will probably demand higher returns to make room for more T-bills and dealers will scramble for financing to hold them, analysts said.
A jump in T-bill supply comes at a time when bond dealers have already increased their Treasury holdings five fold due to more federal borrowing stemming from the massive tax cut enacted in December 2017.
(GRAPHIC – U.S. primary dealers Treasury holdings: https://tmsnrt.rs/2Ms5xPU)
Dealers do not have a lot of room for a huge jump in bill supply so the Treasury needs to manage the increase gradually to avoid market disruption, analysts said.
“This could exacerbate some cracks if they make a big push in bills,” said Tom Simons, senior money market economist at Jefferies LLC.
The Treasury is expected to issue anywhere from $100 billion to $200 billion beginning in August in an effort to increase federal cash holdings to $350 billion at the end of September.
The government’s cash position stood at $161 billion on Thursday, down from $423 billion at the end of April.
To return to a projected level of $350 billion by the end of September, most Wall Street analysts are projecting the Treasury would ramp up its weekly offerings of one-month and two-month T-bills in combination with possible issuance of cash management bills.
The U.S. government budget gap is projected to grow to $1.026 trillion in 2019 from $932 billion the year before, according to Morgan Stanley (NYSE:).
The Treasury’s new borrowing this year is expected to total $1.201 trillion with $129 billion coming from selling T-bills.
(GRAPHIC – U.S. Treasury operating cash balance: https://tmsnrt.rs/2ypOHsI)
By 2021, the federal deficit would grow to $1.242 trillion with $232 billion in new borrowing in the form of T-bills, Morgan Stanley analysts wrote in a research report released Monday.
In the July-September quarter, the Treasury said late Monday it planned to borrow $433 billion, about $274 billion more than its earlier projection.
More short-term government debt will likely make owning that debt relatively expensive for bond dealers.
On Tuesday, dealers were paying an interest rate of 2.46% in the repurchase agreement (repo) market to fund their Treasury holdings. This compared with Fed’s current target range on short-term rates at 2.25%-2.50%.
“This would put upward pressure on repo rates. The Treasury does not want to cause a major disruption in money markets,” said Jonathan Hill, U.S. rates strategist at BMO Capital Markets.
Repo rates will likely rise even as the Fed is widely expected to lower key lending rates for the first time in a decade on Wednesday.
Earlier that day, the Treasury is scheduled to discuss its details on upcoming bills sales and quarterly refunding.
The Treasury asked primary dealers, or the top 24 Wall Street firms which do business directly with the Fed, this month about the pace of T-bill supply increases to restore its cash position without disrupting the market.
(GRAPHIC – U.S. budget gap: https://tmsnrt.rs/2O9kEjM)