On Saturday, US President Joe Biden and the Speaker of the US House of Representatives announced a preliminary agreement on the public debt ceiling of $31.4 trillion, after tough negotiations with Republicans.
The deal, to be voted on Wednesday, will suspend the debt ceiling until January 2025, after presidential elections in November 2024, in exchange for setting a spending cap and cuts to government programs.
The most important concerns still worrying the financial markets:
- Although Republican House Speaker Kevin McCarthy expected the debt ceiling deal to have the support of a majority of his party’s representatives, it is expected that the agreement faces a difficult road to pass in Congress, before the date set for the government’s default on its debt on June 5.
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McCarthy will appear to face challenges passing the deal, which has been criticized by Republicans in the House and Senate, as Rep. Chip Roy, a prominent member of the House Freedom Caucus, said on Twitter, “We will try” to prevent the approval of this agreement in the House.
– The other thing investors are worried about is that once a deal is struck, the US Treasury is expected to rush to bail out its cash balance by issuing over $1 trillion in bonds of the Treasury until the end of the third quarter, according to Bloomberg, which would absorb a large amount of liquidity from the financial markets.
- According to Bloomberg, the stock of US cash currently stands at $39 billion, the lowest level since 2017.
The deluge of short-term Treasury bonds, which JPMorgan estimates at around $1.1 trillion over the next seven months, which is a relatively large amount in this short period, will be a stressor on money markets because it adds pressure on liquidity at a time when the reserve works, the Fed originally intended to limit financial conditions by raising interest rates and shrinking its balance sheet.
- Analysts also believe that the issuance of bonds by the US Treasury at this rate, and at current high interest rates, will make it a competitor to banks, which could lead to a depletion of bank reserves, as deposits from private companies and others will shift to more profitable and relatively safer government bonds.
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These outflows of bank deposits will put increased pressure on cash and cash available in banks, and could increase the rates applied to short-term loans and bonds, and make financing more expensive for businesses and individuals who are mainly suffering high interest rates.
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Bank of America analysts expect this to have the same economic effect as a 25 basis point interest rate hike, putting additional pressure on the market, which is already expecting that the Federal Reserve raises the main interest rate by 25 basis points in July.
“Our concern is that if, for whatever reason, liquidity begins to leak out of the financial system, it creates an environment in which markets are vulnerable to collapse,” said Alex Lennard, chief investment officer of the global financial services firm. Rover Asset Management.
Mike Wilson, equity strategist at Morgan Stanley, agreed, saying: “Treasury issuance will suck market liquidity and could act as a catalyst for the equity correction we’ve been waiting for.”
- But, according to Reuters, the outflow of cash is not a foregone conclusion, as the issuance of Treasury bills can be partially absorbed by money market mutual funds.
Bankers and experts say the risks associated with the depletion of cash from bank reserves will persist until the deal is reached in Congress and the steps the Treasury will follow to rebuild its cash stocks, in addition to wait for action from the Fed at its next meeting in July.
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