The US Treasury Department’s plan to significantly increase debt issuance in the fourth quarter is likely to make it more costly for banks and asset managers to borrow in the crucial $2.5 trillion repurchase agreement market, which could tighten credit conditions across the economy.
Last month, the Treasury said its debt issuance would swell to $501 billion in the fourth quarter, up from $96 billion in the third quarter. Analysts expect Treasury bills, which have short maturities, to account for the lion’s share of the new debt. The increase in issuance is likely to tighten bank balance sheets at the same time as they typically contract for year-end.
Money market funds, the largest lenders in repurchase agreements, otherwise known as repos, are expected to increase purchases of Treasury bills at the expense of making loans in repo, making the loans more expensive. The government will need to increase debt sales to replenish its cash levels after being restricted in the third quarter by the debt limit. The Congressional Budget Office has said US lawmakers need to raise the debt ceiling by mid-October to avoid defaulting on debt payments.
While conditions are likely to tighten, it is not yet clear whether it will rise to levels that disrupt markets. Longer-term, repo rates may remain elevated as the Treasury faces rising cash needs from an aging population and as the Federal Reserve is expected to reduce its bond purchases, with financing needs expected to jump in the second half of 2018. It may also reduce the amount of US dollars in circulation, making it more difficult for foreign banks to borrow the currency.
As the Federal Reserve pares the size of its balance sheet, the amount of reserves that banks hold with the US central bank will decline, if higher rates paid on treasury bills are deemed more attractive than holding the reserves. A decline in reserves would mean that fewer dollars are circulating in the market, with foreign banks likely hardest hit.