The enormous Treasury issuance that may follow the debt ceiling resolution

What does this large Treasury debt issuance mean in plain English?

QT potentially gets steroids. We've been on a vacation from it, in essence, since October because initially all of the PBoC and BoJ expansion of liquidity. Then Treasury issuance paused in mid-January. This has all helped to boost the markets.

Now Treasury issuance is coming back, and in a big, big way to fund increased deficit spending. This while we've seen PBoC and BoJ a bit less aggressive in their monetary measures. Why does this matter? Because it is likely to significantly amplify the impacts of QT by draining bank reserves.

We’re also contending with a time when interest rate expenses as a component of deficit spend are rising quite significantly, to hit over $1T/year. That will amplify issuance of debt that simply pays off the interest of other debt.

While some have suggested it was TGA spending that added liquidity to the market, I would say that TGA spending is a very, very temporary driver as most of it is paying bills, and those bill payments don't often stay in bank reserves for too long. That money often has velocity.

The resumption of issuance is actually a big deal, as the absence thereof has helped to subdue the tightening impact of QT and high rates. Now that we're facing up to $1.2T of issuance by September 30th and $700B within weeks of the debt ceiling resolution, it's time to consider impacts.

The most likely initial impact is a removal of excess liquidity. Particularly if the reverse repo market continues to stay well supported, with over $2T parked daily in the overnight facility yielding at about 5.05%.

Should we see that drop in bank reserves, it will have the impact of removing liquidity from the financial system. This lack of liquidity in Treasury markets also tends to put upward pressure on rates and drive broader realized and possibly implied volatility across multiple markets.

That upward pressure in rates could drive rate-sensitive risk assets lower, such as stocks, crypto. Particularly the longer duration risk, like tech, growth stocks, and other more speculative assets.

Why does this matter? Because it may mark the end of this prolific bear market rally. But more important than that, it may reintroduce a lot of risk that's ostensibly been on vacation to the global financial markets.

The debt issuance must complete by September 30th because it is the end of the government’s fiscal year, and there's a lot of budgets that need to be satisfied before then. As a result, the majority of issuance we see is likely to kick off before then. Right now it is expected to be $1.2T in total size.

From Business Insider, “Goldman estimated that bank reserves would drop by $400 billion-$500 billion due to the Treasury rebuilding its cash balance, continued deposit outflows, and the Fed's ongoing quantitative tightening program.”

While some expect money-market funds to absorb the additional issuance, others are skeptical. Money-market funds, “over the past year these funds have been shedding bills,” the Goldman team wrote, in a weekly client note. This is particularly revealing because during the past year money-market funds also saw a rather significant surge of inflows.

We also have not seen a large outflow from RRP even with the bill issuance that we saw in 2022. That suggests that if the same behavior remains a constant, that there isn’t any reason to believe funds will come from there in a large manner that offsets the liquidity impacts we’ve discussed.

After all, it’s attractive to banks and other financial institutions to park funds in a facility that has a very short duration such that they can be withdrawn on an as needed basis. Even money market funds have been parking a lot of cash at RRP.

As a result of this large debt issuance that’s coming soon, it is likely we see more volatility in both Treasury and equity markets. The summer duldroms also tend to make for choppier trading — as liquidity naturally tends to dry up between June through September.

Seasonality also suggests similar, particularly with negative leading economic indicators. That is to say, in periods from June through September when leading economic indicators are falling, we often see negative returns in the US stock market.

All of this suggests that this may be a summer where caution is warranted, particularly in riskier parts of the market.