The Treasury has been relying on issuance of short-term T-bills to reduce the cost of servicing the government’s growing public debt.
With a debt of $37 trillion, the government will spend an estimated $950 billion in interest payments alone this year.
Money market funds have so far been willing to absorb these short-term Treasury bills. But how long can that condition hold?
As market players price in more rate cuts, demand for shorter-term paper will increase. Should that occur in the near term, the Treasury will have to step up its issuance of longer-term paper in which investors will demand a greater yield on top of a risk premium as the Fed cuts rates into rising inflation.
As indicated by the drawdown of capital by money market funds using the Federal Reserve’s repo facility, investors would rather lock in the return of a 3.85% Treasury bill for six months than risk the return on overnight rates expected to drop if and when the Federal Reserve begins to cut its policy rate.
Use of the facility ensures liquidity in the money markets and adequate reserves in the banking system. The difficulty for the Federal Reserve comes with the draining of the facility.
In addition, if the markets become overloaded with short-term exposure, the Treasury will be forced to return to relying on issuance of longer-term securities.
