What’s Next For the Treasury General Account?
A New Source of Worries for Bank Treasurers and Deal Makers After the Debt Ceiling Resolution
June 02, 2023
A near collision often has consequences that, while less severe than a complete wreck, still leaves substantial damage in its wake. This is certainly the case with the successful conclusion of the debt ceiling negotiations. There will be countless political and budget repercussions that have been widely discussed. One of the less discussed but immediate consequences is the need for the United States Treasury to replenish the Treasury General Account (“TGA”). And that replenishment will affect many parts of the economy, and most particularly bank balance sheets and capital market liquidity.
Treasury General Account. The TGA is the account at the Federal Reserve where the Treasury holds funds to pay the country’s bills. The level of funds in the account affects reserves in the financial system, and the greater the size of the account, the less liquidity otherwise in the system. Typically, Treasury targets a $500-600 billion balance to provide a sufficient buffer: in May 2022, the account balance was $782 billion.1 As the Treasury implemented “extraordinary measures” to avoid breaching the debt ceiling, the balance has come down, and was as low as $49 billion in May of this year.2 The falling balance has effectively added liquidity to the markets at the same time that the Federal Reserve provided additional liquidity following the collapse of Silicon Valley Bank (“SVB”) and several other regional banks.
The Treasury will replenish the TGA immediately after the increase in the debt ceiling. It is widely expected that the target will be in the range of $600 billion,3 which will have the effect of draining this amount from the financial system. This withdrawal of liquidity is likely to occur at the same time that Treasury is issuing additional term debt that it deferred during the runup to the debt ceiling crisis, draining additional liquidity from the system. PIMCO anticipates perhaps a total of $1 trillion or more in new T-bill supply.4 To put the TGA refunding in perspective, the Fed’s monthly quantitative tightening (“QT”) target is $95 billion, so a rapid $600 billion replenishment of the TGA is likely to be felt quickly in the capital markets.
Information from the Fed’s FRED database reinforces the conclusion that bank treasurers and market participants could soon face substantial liquidity challenges. The Fed quickly increased the size of its balance sheet after the regional banking crisis: total assets at the Federal Reserve Banks increased by nearly $400 billion in the two weeks from March 8 to March 22, 2023. Those holdings had dropped by $300 billion through May 24.5 If the Fed continues to reduce the funding it temporarily provided at the time of the SVB and other bank failures while continuing to reduce its balance sheet through its planned monthly quantitative tightening of $95 billion, the TGA refunding will quickly add further stress on market liquidity in a short time period.
Impact on Bank Balance Sheets. There are likely to be consequences to many parts of the economy from this withdrawal of liquidity. For bank treasurers, a principal concern is that the government will need to offer higher rates to entice investors like money market funds to purchase the new government debt, forcing banks to increase the amount they pay on deposits to avoid a deposit outflow. This reduction in market liquidity will occur at the same time that regulators will be focusing on bank liquidity following the regional bank failures.6 All of this promises to put enormous pressures on bank treasurers as they manage their balance sheets and seek to maintain the margins on their net interest income. According to Bank of America, the reduction in liquidity may be equivalent to a 25 basis point increase in interest rates.7
“Bank treasurers need to ensure they are capturing evolving market dynamics in their scenario planning and stress test testing processes,” commented Scott Freidenrich, former BNY Mellon Treasurer and now a Senior Advisor to FTI Consulting. “The imminent near-term increase in the TGA and the Federal Reserve’s continuation of quantitative tightening impact the total amount of reserves in the system. This combined with the potential for further central bank rate hikes to combat inflation increases the potential for deposit volatility and fluctuations in the value of securities portfolios. Simultaneous consideration of multiple variables, including current market factors, in stress testing is an important risk management strategy and is increasingly expected by regulators given their enhanced focus on liquidity,” Freidenrich concluded.
Impact on Market Liquidity. Deal flow has been dismal in virtually every market segment for nearly a year. Worldwide deal flow in the first quarter of this year was at one of its lowest levels in the past decade.8 The concern with reduced liquidity from likely Fed and Treasury actions is that it will exacerbate an already challenging deal market: commercial real estate is highly troubled, concerns about an economic slowdown are impacting valuations, continued elevated inflation reports increase the possibility of further central bank rate increases. The combination of reduced liquidity, a possible economic slowdown, and elevated interest rates are weighing on a difficult deal market.
The likely drawdown in liquidity from TGA replenishment could negatively impact deal volume for the remainder of the year. Morgan Stanley recently recommended that investors proceed cautiously due to the combination of economic concerns, stress on regional banks, and their expectation of an $650-750 billion reduction in market liquidity from new Treasury issuance following conclusion of the debt ceiling negotiations.9 PIMCO, anticipating perhaps $1 trillion or more in new T-bill supply, cautioned investors to “keep an eye on liquidity costs and conditions” after a debt ceiling deal.10 This reversal in the provision of central bank liquidity is almost certain to create headwinds for any uptick in deal activity.
Conclusion. Even though virtually all observers expected the debt ceiling negotiations to conclude without a default, there is still an understandable sense of relief that this is occurring. It is natural to move on to the next source of worry, perhaps ignoring the crash that didn’t happen. The combination of the need to replenish the TGA account, the persistence of inflationary pressures that increase the likelihood of further central bank rate increases, the continuation of quantitative tightening, and the expected withdrawal of temporary liquidity provided at the time of the regional bank failures together present a new set of threats to bank treasurers, deal makers, and their advisors. The debt ceiling crisis may be in the rear-view mirror: parts of its wreckage may still lie ahead of us.
1: “Treasury Announces Marketable Borrowing Estimates,” U.S. Treasury Department press release, Aug. 1, 2022, https://home.treasury.gov/news/press-releases/jy0902
2: David Lawder and Katharine Jackson, “US Treasury cash balance falls to $49.47 bln as of Wednesday,” Reuters, May 25, 2023, https://finance.yahoo.com/news/us-treasury-cash-balance-falls-200000335.html?soc_src=social-sh&soc_trk=ma
3: Liz McCormick and Alex Harris, “Wall Street Fears $1 Trillion Aftershock from Debt Deal,“ Bloomberg, May 18, 2023.
4: Libby Cantrill, Jerome Schneider, Tiffany Wilding, “Debt Ceiling Debate: Examining Risks Around the X-Date,” PIMCO Viewpoints, April 27, 2023.
5: FRED Economic Data, St. Louis Fed, “Total Assets, Wednesday Level.”
6: Telis Demos, “For Banks, Debt-Ceiling Drama Doesn’t End with a Deal,” Wall Street Journal, May 24, 2023.
7: Liz McCormick and Alex Harris, “Wall Street Fears $1 Trillion Aftershock from Debt Deal,“ Bloomberg, May 18, 2023.
8: Emily Rouleau, “Analysis: There Was No Sign of a M&A Market Rebound in Q1 2023,” Bloomberg Law, April 6, 2023.
9: Lisa Shalett, “The Warning Signs Investors Should Not Ignore,” Morgan Stanley Wealth Management, April 26, 2023.
10: Libby Cantrill, Jerome Schneider, Tiffany Wilding, “Debt Ceiling Debate: Examining Risks Around the X-Date,” PIMCO Viewpoints, April 27, 2023.
June 02, 2023
Senior Managing Director, Vice Chair of Client Services