The Treasuries Tsunami Is No Deathtrap for Banks

With the US debt ceiling standoff defused, the Treasury can start borrowing big money again. The government is forecast to issue up to $1 trillion of debt this year in short-term bills, sucking cash out of the US financial system.

This has some bank analysts and market strategists fretting about the dangers to financial stability and the valuation of stocks or other risky assets, especially as the Federal Reserve continues to shrink its balance sheet, unwinding its ultra-loose monetary policies at the same time.

The road could indeed be bumpy. Banks are going to see margins squeezed as they are forced to pay more for deposits. The value of risky assets is going to be hurt by the growing supply of safe US government debt paying decent yields. But lack of liquidity isn’t going to ruin either banks or markets.

The reason: There’s one big pressure valve – and it will either work automatically or the Fed can tweak it any time to ease any strains. It is the reverse repurchase facility, or RRP, that money market funds have been using to park trillions of dollars of spare cash outside of the banking system. All of this money is available to wash back in at the right price as interest rates through the financial system.

To explain, let’s start with the Treasury. During the debt ceiling standoff, the US government kept spending with tight limits on its ability to borrow, which meant running down the balance of its bank account. The Treasury General Account, which is held at the Fed, has declined from almost $1 trillion this time last year to recent lows of less than $50 billion.

The Treasury wants to rebuild its bank balance so it has spare cash to deal with sudden surprises. It aims to raise it to $450 billion by the end of June and $600 billion by the end of September. Some analysts expect it will aim to get higher still by year-end.