Thread by @jameslavish

Good News: The debt ceiling is resolved, so the Treasury will not default.

Bad News: The Treasury’s accounts are drained, and must be refilled with over $1T.

Question is, could this break the markets?

Time for a Debt 🧵👇

😵 The Treasury General Account

Let's start at the top here. What exactly is the Treasury General Account or TGA?

Just like it sounds, this is basically the US Treasury’s checking account

Where it holds cash and pays its bills.

If you’ve been watching the debt ceiling drama, you may have noticed that the account balance recently fell to a precipitous level

It was dangerously close to being overdrawn.

Except unlike a checking account at a bank, there's no overdraft protection for the TGA

Once it hits zero, there’s no courtesy call or $30 'convenience' fee, it’s simply game over

The Treasury *defaults*

But DC eventually figured it out, solved the pending disaster

Problem is, they waited until the absolute last minute to agree

And while waiting, the Treasury had no choice but to burn all its cash, right down to the last pennies (read: billions) left in the TGA.

But now the Treasury is ready to turn the spigot back on, refill its coffers

So, how much liquidity do they need, and where will it all come from?

Some people assume it’ll come from bank reserves and the massive reverse repo balances banks have been sitting on

But it’s a bit more complicated than that, so let’s investigate.

🐷 How much does the Treasury need?

First, how much debt does the Treasury need markets to soak up, and how fast do they have to do it?

Recent reports have suggested that the Treasury targets to return the TGA balance to approximately $550B by the end of June.

This seems to fit with the recent balances and would make sense after the surge in M2 during 2020 (due to massive money printing)

See that spike?

In any case, this means the Treasury needs to float about $500B of USTs in the next few weeks

Not a small sum, but not quite crippling either

A couple of nuances, though, as that's not the full story--they actually need more than that.

First, there are approximately $225B of Treasures that are maturing in June that need to be replaced

*Remember, the US operates in a perpetual deficit and must borrow more to pay off old debts.

This is why the TGA doesn’t just get replenished with US government ‘profits’ or tax revenues

They are all already spent, and then some.

Next, do you remember the whole “extraordinary measures” statement from Yellen a few months ago?

This one.

In essence, the Treasury has been robbing Peter to pay Paul, as they say

And so, on top of refilling the TGA, and paying off maturing debt, the Treasury also has a few internal past-due tabs it needs to clear up, too.

And this is why Goldman and JP Morgan estimate the total amount the Treasury needs to raise is more like $1T to $1.1T

And this is before any QT from the Fed

Remember the $5T in USTs + MBS the Fed stuffed on its balance sheet in 2020 to provide 'market liquidity'?

The Fed's been trying to roll that off its balance sheet, albeit quite slowly thus far

How much?

They are targeting $95B of total asset sales per month.

OK, then where is all this needed liquidity going to come from?

Foreign buyers, like governments, international pension funds, overseas investors?

Maybe some, but don't count on it.

Because, we've recently seen a significant drop in foreign demand for US Treasuries

(credit: bca.co.id)

Hence it will be largely up to US banks and investors to step up to the liquidity plate

We're talking US bank reserves and maybe their stockpile sitting in reverse repo

But which one, and how fast are we talking here?

💵 Reserves and Repos

A little recap on banks and their reserves, first

These are essentially deposits that the banks keep on hand in order to meet leverage and liquidity requirements.

And even though the Fed dropped this requirement to zero in 2020, banks must still meet regulators’ required Liquidity Coverage Ratio (LCR)

And their own internal liquidity measures and requirements

So they don't suffer the same fate as Silicon Valley Bank or First Republic.

As of right now, there are a total of $3.27T of reserves in US banks

So, if the Treasury needs $1 trillion, we’re talking about draining 1/3rd of those reserves. In a month

This would be massive and effectively a form of additional QT.

Remember what we just said a few minutes ago: The Fed has struggled to meet the current QT plan of about $95B per month

The US Treasury needs $1T, or 10X that amount

OK, where else can the Treasury draw from?

The reverse repo slush pile, of course

Maybe.

I talked about all about repos, reverse repos and more in a recent newsletter. If you didn’t see that or want a refresher, you can find it here:
jameslavish.substack.com/p/repos-revers…

TL;DR: Reverse repos are a way for banks to park excess cash at the Fed to earn interest in lieu of reserves

After the Great Money Printing of 2020, a number of banks found themselves sitting on massive piles of cash.

How much cash?

Would you believe $2.1T?

See, banks are limited in the amount of USTs they can buy due to the (SLR or Supplemental Leverage Ratio), and are using the Fed’s reverse repo facility instead

Now you may be thinking: this means much of the reverse repo money likely can’t be used to buy USTs either, then...

True.

And so the Treasury may be forced to issue a lot more shorter-dated paper, i.e., T-Bills, instead of longer-dated USTs

Then cash that is currently parked in the reverse repo facility can be used to fund the Treasury

Because T-Bills fall outside the SLR calculations.

If the Treasury doesn't want to issue T-Bills, then it could work with the regulators to have SLR ratio limits raised so banks can own more USTs

But, if the $1T of USTs soak up reverse repo cash, it's not a form of QT, as this money is otherwise idle

It is not tightening, IMO.

And so, if the Treasury leans this way and finds a mechanism to draw from reverse repo instead of reserves, then the impact of borrowing another $1T can be partially or mostly muted

Otherwise, there will be a tightening effect on the economy.

🛟 Positioning for the Risk

So, where does this all leave us as investors?

In short, I’m waiting to see where exactly the Fed draws this liquidity from, and just how fast they do it.

I'm watching:

• How much paper does the Treasury try to auction in the next few weeks?

• Is it longer or shorter term paper (i.e., which bucket are they taking from, bank reserves or reverse repo)?

• How fast do they float Treasuries, i.e., borrow?

• Do they try to adjust any rules or the SLR calculations?

• And how do the auctions themselves go: Are there signs that the flood of USTs is putting stress on the bond market, in particular? Or does the market remain largely healthy?

If you're wondering how to read the UST market, I wrote all about that here:

https://twitter.com/jameslavish/status/1666502369839050752?s=20

I'm also watching for signs that we're slipping into a recession, which could happen rather quickly, as the Fed has raised rates so dramatically

Because IMO, the true economic impact of all that Fed tightening, and now more coming from the Treasury, have largely yet to be seen.

While I am watching:

• I hold fully-insured FDIC+ cash,

• I'm buying hard monies: #gold and #Bitcoin opportunistically,

• In the event of any market drawdowns or shocks, I will buy those hard monies more aggressively

In short, I would see any large drawdown in markets as a significant opportunity

Why?

Because with all the debt on the US Treasury books, they cannot let markets become illiquid for long. They must keep them stable.

If you're interested, I wrote all about US indebtedness here:

https://twitter.com/jameslavish/status/1666502382216450048?s=20

And here:

https://twitter.com/jameslavish/status/1666502385257299968?s=20

TL:DR: The Treasury and Fed have no choice but to keep the markets liquid in order to keep the debt charade going

And the best way to do that?

An inevitable expansion of the money supply. Which is ultimately good for hard monies like #Gold and #Bitcoin.

This thread is a summary of a recent 🧠Informationist Newsletter.

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