Key Highlights

• Extraordinary measures are running low; Treasury cash balance falling
• Fed increasingly considering a premature end to QT while debt ceiling remains unresolved
• The 2023 episode may not be relevant given current low levels of RRP balances

Getting nervous

EXHIBIT #1: RUNNING OUT OF ROOM?

^{Source: BNY Markets, US Treasury Department}

Through March 5, the US Treasury was down to just $74bn in extraordinary measures still available as it tries to confront the debt ceiling. However, the Treasury’s cash holdings – the Treasury General Account (TGA) – still amount to over $500bn in available funds. Furthermore, in just over a month, US personal income taxes will start trickling into federal coffers. Nevertheless, there remains considerable X-date uncertainty, although most consensus estimates place it in late-July or early-August.

Our take

We have argued that once the debt ceiling is resolved, we could see a rapid rebuild of the TGA, which would likely lead to a similar decline in reserves, creating significant turmoil in funding markets. We have been writing about this since January, soon after the debt ceiling was reached on January 1, 2025 (see here). We have also been of the opinion – stated as recently as last week (see here) – that once the debt ceiling was addressed and Treasury was given more borrowing authority the Fed would end quantitative tightening (QT) at its subsequent FOMC meeting.

However, the minutes of the January FOMC pointed out that “various” Committee participants thought it would be appropriate to consider a change in balance sheet runoff even before the debt ceiling is resolved. System Open Market Account (SOMA) manager Roberto Perli gave a speech last week in which he discussed the balance sheet, QT, and debt ceiling dynamics. The following quote is a good summary of his message:

“Put simply, the longer balance sheet runoff continues while the debt ceiling situation persists, the higher the risk that, upon the resolution of the debt ceiling, reserves could rapidly decline to levels that could result in considerable volatility in money markets. As noted in the minutes of the January 2025 FOMC meeting, various participants thought it may be appropriate to consider pausing or slowing balance sheet runoff until the resolution of the debt ceiling situation.”

This wasn’t the case during the last debt ceiling episode, in 2023, when the debt ceiling impasse lingered until the 11th hour. Between January 19 of that year, when extraordinary measures commenced, and June 2, when the debt ceiling was finally extended, Treasury spent $400bn out of the TGA. That led to a $162bn increase in reserves, and almost no change to RRP holdings. However, after the resolution of the debt ceiling, it took just 60 business days for the TGA to be rebuilt by $438bn. This increase in the TGA, however, didn’t really change the level of reserves, but instead led to a significant drainage of RRP balances, from $2.1trn down to $1.57trn.

The issue is that with RRP balances now so low – fluctuating at around just $100bn per day – the TGA rebuild will be felt in lower reserve balances at the Fed, potentially creating a liquidity squeeze in funding markets. There is just not enough cash in RRP for the increase in TGA liquidity to be offset fully by running RRP down further. This puts the burden of adjustment on reserves. A sudden drain of Treasury liquidity could cause a sudden decline in market liquidity.

Forward look

We don’t know when the debt ceiling will ultimately be resolved, and we don’t know how quickly or how much the TGA will be replenished when the ceiling is dealt with. This uncertainty has apparently made some members of the FOMC nervous about interpreting liquidity conditions in the markets and has led to some calls to end QT sooner rather than later.

While we don’t expect any action on QT to be announced next week at the March FOMC meeting, we do acknowledge that at future FOMC meetings, the Committee consensus could favor a QT pause if the debt ceiling is still unresolved. At present, there are very few indications of repo strain in the markets and as the TGA paydown continues apace, reserves should be more than adequate for proper market functioning. However, this concern, and the opacity created by these dynamics could spur an end to QT sooner than we anticipate. For the time being, however, we are sticking with our conditional forecast – QT will end when the debt ceiling is resolved.

EXHIBIT #2: THE 2023 DEBT CEILING EPISODE MAY NOT BE A PROPER ANALOGY FOR NOW

^{Source: BNY Markets, US Treasury Department, Federal Reserve Board of Governors}