NEW YORK The impending showdown over raising the U.S. debt ceiling is creating distortions in short-term Treasury bills, and as the government pares back new debt sales some worry that bills needed to back trades and loans will become increasingly scarce.
U.S. Treasury Secretary Jack Lew warned Congress the United States would exhaust its borrowing capacity no later than October 17, at which point it would have only about $30 billion in cash on hand.
The fresh estimate adds more pressure on lawmakers to raise the $16.7 trillion debt limit as Congress struggles to also pass a spending bill to keep the government funded beyond October 1, when the new fiscal year starts.
Wrangling over raising the debt limit is leading some investors to avoid Treasury bills that mature in late October and early November, a repeat of previous dislocations, such as in the summer of 2011, when the risk of a U.S. debt default existed.
Other Treasury bills that mature outside of this time frame, meanwhile, have seen their yields drop to zero and, in many cases turned negative, as investors fret that the Treasury will have to slash its debt sales to stay under the debt ceiling. As a result, investors are paying the government to lend to them.
"The greater systemic risk may actually be a lack of high-quality collateral in the system, which has forced some investors to accept a negative yield for their Treasury bill investments," said Kenneth Silliman, head of short-term rates trading at TD Securities in New York.
The Treasury on Thursday said it would sell $25 billion in three-month bills next week, a $5 billion cut from the last three-month sale, a sign that the government is already trying to add more room under its debt limit.
"If it weren't for the debt ceiling I don't think they would have cut the size," said Thomas Simons, money market economist at Jefferies & Co in New York. "That is creating some concern that supply is going to fall further, and we're right in front of quarter-end."
Treasury bills often see strong demand heading into quarter-end rebalancing at the end of September when companies and investors seek out higher quality debt to polish their balance sheets.
That need comes on top of already strong regular demand for short-dated debt, which is used to back loans in the $5 trillion repurchase agreement market and to post against trades including derivatives.
The U.S. Treasury may have to shift to even shorter-dated debt sales such as cash management bills to smooth out imbalances as it cuts back on bill issuance.
"These types of things are going to be necessary in order to smooth out cash shortfalls that are going to be generated," said Simons.
A potentially mitigating factor may be the use of the reverse repurchase facility, a new tool that is meant to help the U.S. central bank control short-dated interest rates.
The New York Fed began testing this facility this week, and on Thursday it said it will raise the allocation limit to $1 billion per counterparty from the current level of $500 million.
"We feel that the Fed is paying close attention to this development, which has probably influenced their decision to raise the size of the overnight reverse repo facility," said Silliman.
In reverse repurchase agreements, or reverse repos, the Fed temporarily drains cash from the financial system by borrowing funds overnight from banks, large money market mutual funds and others, and offering them Treasury securities as collateral. Banks and the funds receive a modest overnight interest rate, initially set at 0.01 percentage point, or 1 basis point.
The New York Fed said on Friday it accepted $16.62 billion in cash from 50 bidders in the facility, the highest daily figure since it began testing on Monday.
The Fed said it may test the facility until the end of January.
(Editing by Kenneth Barry)