The Retired Investor: Government Bond Borrowing Could Cause Disruption

The debt ceiling crisis has come and gone but the financial markets did not get away scot-free. The bond market is facing an avalanche of new bond sales that could pressure interest rates higher.

 

The government's bank account, called the Treasury General Account, is practically empty in sovereign terms. Today, there is less than $50 billion in the account as of June 2, 2023.

 

The U.S. Treasury has been draining this account since January 2023, when the government debt ceiling controversy started to heat up. The government cut back on the number and amount of bond auctions, which were almost a weekly feature of sovereign debt financing in normal times.

 

The dearth of new supplies of government bonds added liquidity to the financial system. As the fear of a government default grew, yields on government bonds rose and liquidity continued to increase. Where did all that money end up — in the stock market?

 

It explains to some extent why investors flocked to the FANG stocks. Investors sought the largest, safest, most liquid equities they could find as bond equivalents. Stocks continued to climb as liquidity increased.

 

Could we be facing a reverse of this situation as the supply of Treasury bills increases in the months ahead? The answer depends on how much money the government will need to raise in the short term.

 

Experts expect the government will need to raise as much as $1 trillion-$1.4 trillion in Treasury bills over the next six months just to return the government's balances to normal. That would include continued funding of the U.S.'s day-to-day needs.

 

If that estimate proves to be accurate, it would be the largest issuance of Treasury bills in history (excluding the major financial crisis of 2008 and the pandemic in 2020). To put this in perspective, the money needed to be raised would be about five times the supply of bills in an average three-month stretch in the years before the pandemic.

 

On the negative side of the ledger, dumping that amount of bills onto the market, while the economy appears to be slowing, is risky enough. If one also includes the problems in the regional banking sector, then we may be flirting with financial danger. Siphoning a lot more money out of the banking system, which has already seen enormous outflows because of the regional banking crisis, would force these banks to raise more cash.  Their financing costs would rise and stress an already fragile system.

 

However, some positives could mitigate some of the risks. Currently, more than $2 trillion is sitting in money market assets yielding over 5 percent at the Federal Reserve Bank's overnight repo facility. This money is what I call "yield-hungry assets" that can move to wherever the return in yields is greatest. That money could easily support the government's treasury bill auctions, but the price of that would be higher interest rate yields.

 

What that may mean for you and me, is an opportunity to earn even more on your money market funds this summer. It could also mean an overall rise in yields on two-, three-, and four-year bonds, which could also offer bond investors opportunities. It could also cause some disruption in the stock market during the same period. Time will tell.

 

Bill Schmick is the founding partner of Onota Partners, Inc., in the Berkshires. His forecasts and opinions are purely his own and do not necessarily represent the views of Onota Partners Inc. (OPI). None of his commentary is or should be considered investment advice. Direct your inquiries to Bill at 1-413-347-2401 or email him at bill@schmicksretiredinvestor.com.