Key Highlights

• With the debt limit now lifted, T-bill supply will increase
• Increased T-bill supply will decrease overall system liquidity
• We expect reserves to fall and money market rates to inch higher

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EXHIBIT #1: BILL SUPPLY, TGA SET TO INCREASE

_{Source: BNY Markets, Federal Reserve Board of Governors, U.S. Department of Treasury}

With the passage of the Republicans’ budget bill last week, the U.S. statutory debt ceiling has been increased by $5tn. This opens the gates for the Treasury Department to ramp up T-bill supply, which had been curtailed since the beginning of the year. We expect T-bill demand – both from the money market fund (MMF) community as well as real money investors – to match supply when it becomes available. This should put upward pressure on money market rates and lead to a decline in usage of the Fed’s overnight reverse repo facility (the RRP).

After peaking in mid-February this year, net T-bill issuance fell by some $650bn through the end of last week. With the debt cap now lifted, we expect bill issuance to pick up, as Treasury refills its general account (the TGA). As Exhibit #1 shows, the TGA was down to around $370bn through the end of last week. This is not quite as low as we saw the TGA back in mid-2023, when the last debt ceiling episode wasn’t resolved until the 11th hour.

At the time, the TGA had fallen to just $23bn (on June 1, 2023). The subsequent increase in T-bill issuance amounted to almost $1.6tn between then and the end of the year, bringing the TGA up to just under $840bn by the end of October 2023. If we assume that the TGA will return to around $850 over a similar amount of time, we can expect around $500 in issuance just to bring the account back to its stated target level. That is in addition to any short-term borrowing required to fund government spending. It’s conceivable that between $700bn and $1tn in bills could be brought to market by December. Of course, the Treasury quarterly funding statement, due out at the end of this month, could produce a lower target for the TGA, perhaps limiting new supply below 2023 rates, even with proportionally higher bill issuance versus coupons (see Exhibit #2).

EXHIBIT #2: WATCH THE THREE LINES!

_{Source: BNY Markets, U.S. Department of Treasury, Federal Reserve Bank Board of Governors}

The dearth of new T-bills has led MMFs to decrease their asset allocation (of a total of over $7tn in assets) into the Treasury market. According to Crane Data, in December 2024,  before T-bill issuance dropped, MMFs’ asset allocation featured $2.985tn in USTs, or about a 40% slice of the asset allocation pie. This compares to a 37% share for repo. Fast forward to the end of May, the latest period for which we have data, and the asset allocation is inverted, with 42% of MMF assets now deployed to repo and 37% into Treasurys. This represents a decrease of nearly $300bn over that period for USTs and an increase of around $360bn in repo.

Note that RRP usage has drifted higher over the same period that T-bill supply has dwindled, with current take-up at over $200bn. We wrote about this some time ago (see here). In recent publications, we have also asserted that T-bill demand from both MMFs and real money is generally inelastic to supply. This suggests that money funds and asset managers will re-enter the bills market once supply resumes, and RRP balances will decline.

T-bill supply and the related refill of the TGA will reduce overall liquidity, as it drains banking system reserves. Already, in less than a week since the budget bill passed, term repo is inching higher for longer-than-overnight liquidity. Exhibit #3 shows term repo rates as of the morning of July 7 and compares them to one month before. The quarter-end period in the final days in June witnessed some market tightness, with both RRP balances soaring temporarily (up over $450bn) and repo rates higher, although as July has progressed these two indicators have normalized. The Fed has made its standing repo facility (the SRF) open in mornings as well as afternoons to backstop the public funding markets, perhaps in anticipation of potential eventual liquidity challenges.

EXHIBIT #3: TIGHTER TERM FUNDING MARKETS

_{Source: BNY Markets, Bloomberg} 

To summarize, T-bill supply will increase now that the debt limit has been extended. The amount of new issuance and over what time frame it will take place is dependent on a couple of current unknowns, namely how high Treasury wishes to take the TGA, and where along the yield curve the government aims to finance itself. We expect bill supply to increase as soon as this week, and ultimately the two questions above will be addressed at the end of July with the financing statement. However, we expect the implications to be clear, whatever the final quantity of bills put into the market: MMFs and real money will likely take up the new supply with the former less involved in repo, hence reducing liquidity and leading to tightness into funding markets.

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