Treasury raises cash for a rainy day

| June 5, 2020

This document is intended for institutional investors and is not subject to all of the independence and disclosure standards applicable to debt research reports prepared for retail investors.

When Treasury a month ago announced estimates of borrowing needs for the second and third quarter, the Treasury debt managers seemed far too pessimistic about the near-term budget outlook. The Treasury’s cash balance has steadily increased since then as heavy issuance, particularly of cash management bills, has far exceeded the federal government’s financing needs. With the cash balance nearing $1.5 trillion, nearly double the Treasury’s target, government debt managers may need to rethink their borrowing strategy soon.

Treasury’s estimated borrowing needs

In advance of each quarterly Treasury refunding announcement, federal debt managers offer estimates for the federal government’s projected borrowing needs for the current quarter and the next one.  The most recent figures released on May 4 looked shocking.  The Treasury declared that it expected to need to borrow $3 trillion in the second quarter alone, assuming a June 30 cash balance of $800 billion.

For the third quarter, Treasury expected to need to finance $677 billion, again assuming an end-of-quarter cash balance of $800 billion.  That would yield a staggering $4.5 trillion in marketable borrowing for the federal fiscal year 2020 ending on September 30.

While the Treasury does not directly offer the assumptions for the budget deficit that underpin these estimates, the $4.1 trillion “financing need” for the year presumably includes a deficit projection somewhere between $3.50 trillion to $3.75 trillion.

A less pessimistic scenario

In contrast, my estimates, which were made before the Treasury’s figures were announced, were also astonishing but much less aggressive.  My deficit estimate for the year was $2.9 trillion, with total borrowing needs for the fiscal year of about $3.25 trillion when adjusting for the Treasury’s cash balance target.  The most surprising aspect of the discrepancy was that it was entirely in the second quarter, a 3-month period already more than one-third complete. It would have been entirely understandable if there was a wide gap between Treasury’s and my estimates because of vastly different assumptions about the next stage of fiscal policy measures, but presumably, by the beginning of May, most prospective fiscal measures that could have realistically passed Congress would have mainly resulted in money going out the door in the third quarter.

As it happens, the median primary dealer estimate provided at that time for FY2020 was higher than my budget projection, but the median dealer estimate for Treasury’s marketable borrowing need was roughly consistent with my figures and much lower than the Treasury’s own assumptions.

In a time of such flux in fiscal policy, I would normally be inclined to presume that when my numbers are far away from the Treasury’s debt office estimates, they may know something that I am not privy to.  However, in this case, it was hard for me to envision what might happen over the next 57 days that could be worth an extra $800 billion in borrowing.

Actual results

Based on the gradual increases in coupon auction sizes announced in the Treasury’s refunding statement and steady weekly bill offerings at current sizes, the Treasury’s game plan implied that a steady diet of cash management bills would need to raise about $1.85 trillion by June 30.  Treasury established a regular schedule of cash management bill auctions for  that purpose.

If Treasury maintains the current schedule and sizes of cash management bills through the end of the current quarter, it will actually raise about $3.13 trillion over the course of the second quarter, $140 billion more than the sky-high estimate offered on May 4.

However, the budget trends through early June have been closer to my estimates.  As a result, the Treasury has been borrowing more than it needed to pay its bills and its cash balance has steadily accumulated over the past several weeks, reaching an all-time high of $1.46 trillion as of Tuesday before receding slightly on Wednesday.

Time for a change?

The Treasury’s cash balance is well over $600 billion higher than its May 4 target for June 30 and likely to grow further if the current auction calendar is maintained.  One explanation for the swelling cash balance is that Treasury is preparing for a coming massive cash drain that will accompany some of the programs designed to respond to the COVID crisis.  Treasury is on the hook for hundreds of billions of dollars if and when PPP loans begin to be forgiven.  Moreover, Treasury will be continuing to provide equity backstop money for the various Fed lending facilities and may need to offer still more if new facilities are rolled out or existing programs are expanded.

My budget estimates detailed above still had ample provision for the PPP expenditures as well as other COVID-related spending, so Treasury’s borrowing needs estimates still appear overly aggressive.  Moreover, the recent legislation extending the deadline for businesses to use their PPP money will likely push off the timing for the forgiveness of those loans, and it looks like the uptake on various Fed lending facilities will not be sufficient to necessitate any additional expansion for the time being. Barring a sharp change to the near-term fiscal situation, Treasury may need to revisit its cash management auction schedule in the next month or two. Cash management bill auction sizes should shrink at some point soon.

Treasury-Fed yield curve trade?

One implication of the Treasury’s swelling cash balance that may not be immediately obvious is the interplay between the actions of the Fed and Treasury.  Since mid-March, the Fed has bought immense amounts of Treasury coupons, adding up to around $1.6 trillion.  This accounts for the majority of the nearly $3 trillion swelling in the Fed’s balance sheet since early March.

If you want to think of a consolidated federal government balance sheet encompassing both Treasury and the Fed, then this “trade” amounts to the world’s largest SIV, buying massive amounts of medium- and long-term Treasuries and funding the purchases with gigantic amounts of short-term debt.  While that is not a fair characterization of the intent of the Fed and Treasury, which ostensibly act independently from each other, the practical effects for bond market participants are no different than if the two entities were coordinating.

john.killian@santander.us 1 (646) 776-7714

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