Now that the debt ceiling has been lifted, and the world is seemingly a better place following the US averting any default, is there any collateral damage due to the debt ceiling being lifted? With all the potential political fallout being discussed to death, a minor detail has not enjoyed the same amount of air time that the political situation has enjoyed. That is the question of how the US Treasury will replenish the Treasury General Account (“TGA”), and how that replenishment will affect many parts of the economy, and most particularly bank balance sheets and capital market liquidity.
First, what is the TGA?
The TGA is the account at the Federal Reserve where the Treasury holds funds to pay the country’s bills. The level of funds in the account affects reserves in the financial system, and the greater the size of the account, the less liquidity otherwise in the system. The Treasury normally wants this balance around the $600 billion mark, and as it neared the end of the debt ceiling discussion it was as low as $49 billion. The falling balance has effectively added liquidity to the markets while the Federal Reserve provided additional liquidity following the collapse of Silicon Valley Bank (“SVB”) and several other regional banks.
Now that the debt ceiling can be lifted, the Treasury will immediately go about getting the balance back toward the $ 600 billion mark. This means in order for the Treasury to top up the account, it needs to drain that amount of liquidity from the market. This withdrawal of liquidity is likely to occur at the same time that Treasury is issuing additional term debt that it deferred during the runup to the debt ceiling crisis, draining additional liquidity from the system. To put the TGA refunding in perspective, the Fed’s monthly quantitative tightening (“QT”) target is $95 billion, so a rapid $600 billion replenishment of the TGA is likely to be felt quickly in the capital markets.
If the Fed continues to reduce the funding it temporarily provided at the time of the SVB and other bank failures while continuing to reduce its balance sheet through its planned monthly quantitative tightening of $95 billion, the TGA refunding will quickly add further stress on the market liquidity in a short time period.
What does this do for market liquidity?
The US Banks could be in a bit of strife as there are likely to be many consequences with the withdrawal of liquidity. One problem the bank sits with is that with the government issuing new debt, they need to offer higher rates in order to entice the market to purchase it. This will force the hand of banks to offer higher rates on deposits to avoid a liquidity drain. This reduction in market liquidity will occur at the same time that regulators will be focusing on bank liquidity following the regional bank failures. All of this promises to put enormous pressure on bank treasurers as they manage their balance sheets and seek to maintain the margins on their net interest income. According to Bank of America, the reduction in liquidity may be equivalent to a 25 basis point increase in interest rates.
The concern with reduced liquidity from likely Fed and Treasury actions is that it will exacerbate an already challenging deal market: commercial real estate is highly troubled, concerns about an economic slowdown are impacting valuations, continued elevated inflation reports increase the possibility of further central bank rate increases. The combination of reduced liquidity, a possible economic slowdown, and elevated interest rates are weighing on a difficult deal market.