The coming deluge
Following the official suspension of the federal debt limit, expect the U.S. Treasury to issue a massive amount of securities.
Now that the U.S. debt limit is likely to be suspended until January 2025, we turn our attention to the aftermath. The infuriating brinkmanship wasn’t rhetorical, as most political posturing tends to be. It had material repercussions. Investors gave up real money as the dislocation in the Treasury market led them to hold more cash. It also prompted most to avoid securities maturing around the Treasury Department’s estimated default date, instead trading for lower-yielding Treasuries maturing before or after. For that matter, the federal government also lost because it had to offer higher rates to borrowers for those undersold securities.
Cash managers have no time to fume about that now. In the near term, we have to navigate the swiftly changing yield curve to find value. Cash/deposit alternatives, such as money market funds and state pools, increased liquidity out of caution. That amount now needs to be put to work.
The industry also must prepare for a flood of government securities. In the coming months, the Treasury Dept. will play catch up by issuing billions worth of securities to replenish its coffers and make whole the federal accounts in which it redeemed or suspended investments, such as the Civil Service Retirement and Disability Fund. Of course, the lion’s share of the new issuance will go to servicing the debt and spending. Some estimates put that amount as high as $1 trillion. As the most liquid and sought-after securities in the world, these new Treasuries will find homes, but potentially in unpredictable ways.
While this development complicates trading and planning, it should be nothing money managers can’t handle. However, some pundits have voiced concern that the feeding frenzy of government securities will drain liquidity from the markets. The story goes something like this: As a vast number of people, institutions, banks and others lend an unusually large amount to the U.S., their cash reserves will dwindle faster than typical. At the very least, this could widen the margin for error for managing their cash flows; at the worst, it could hamper their ability to deal with a crisis.
We don't think the situation is dire, but it just so happens there’s a set of market participants with plenty of cash and happy to help. Flush with liquidity from massive inflows and prudent management, money funds and pools should be able to absorb much of the massive issuance. The surfeit also might rejuvenate the traditional market for overnight lending, reducing the outsized use of the Federal Reserve’s Reverse Repo Facility. Wouldn’t it be something if the federal government appreciated the existence of money funds?
We hope the resolution of the debt ceiling impasse means the cloud obscuring the direction of monetary policy will dissipate soon. In our opinion, the Fed will not cut rates this year, though it is possible it will raise them. For now, we project that at its June meeting the FOMC will pause to assess the impact of its aggressive tightening cycle. Investors in money funds have long since made that assessment, leading to record total assets under management as the Crane 100 Money Fund Index has climbed to its highest level since 2007. We are positioned to take advantage, with weighted average maturities creeping up within our franchise-wide target range of 25-35 days.