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Better safe than sorry

| October 2, 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.

Federal government finances have bounced all over the place this year as pandemic support and volatility in timing and magnitude of tax payments has created headaches for government debt managers trying to keep the government funded. They have responded by issuing Treasury bills and holding massive cash balances. That remains the strategy for now, but debt managers may have reason to let their cash balance shrink somewhat in the fourth quarter.

Treasury cash balance

Prior to the pandemic, Treasury debt managers sought to maintain enough cash on hand to pay bills for a week to protect against a temporary market disruption. That worked out to around $400 billion. Given the heightened spending and the volatility around outlays and receipts driven by the virus, Treasury debt managers raised their sights and targeted an $800 billion cash balance for both the May-July and August-October quarters.

Notwithstanding their stated target, Treasury debt managers ramped up issuance steeply in the spring and summer, which has pushed the cash balance to between $1.6 trillion and $1.8 trillion since June, at least twice the official target.

Planning for a rainy day

Treasury’s extremely conservative stance likely reflects two key factors, both of which could evolve in the fourth quarter: Paycheck Protection Program loans and a second round of stimulus.

First, the Treasury undoubtedly wanted to keep its cash stores high in advance of the forgiveness of PPP loans. The Treasury and Small Business Administration stood up the PPP program quickly, and banks loaned over $500 billion to small businesses with the understanding that the bulk of the loans would likely be forgiven, that is, the federal government would repay the banks.

The timing of the forgiveness was highly uncertain, but debt managers presumably wanted to be prepared in the event that forgiveness came too rapidly for Treasury issuance to cover up to $500 billion or so in outlays. That may explain close to half of the cash balance overshoot.

Second, having seen hundreds of billions of dollars stream out the door rapidly in the wake of the CARES Act, federal debt managers likely wanted to be ready in the event of a second major round of legislated pandemic support. In particular, with the House-passed HEROES Act totaling a $3.4 trillion, Treasury had to have ample funds on hand in the event that, for example, another round of rebate checks was prescribed.

Outlook for the fourth quarter

Financial market participants and especially money market players have been focused on Treasury’s cash balance and potential large swings in bill issuance. The outlook for the fourth quarter is somewhat uncertain, so Treasury debt managers look unlikely to relax their vigilance and allow the cash balance to shrink all the way back to their official $800 billion target.

PPP loan forgiveness is finally slated to begin soon, but not very many forgiveness applications have even been submitted. While the Treasury may begin to see outflows related to the program in this quarter, it is not clear that it will pay out on all the forgiven loans so soon. If circumstances change, and most or all of the over $500 billion in PPP loans are reimbursed by the federal government before the end of the year, then the cash balance may decline accordingly, but it seems more likely that at least some of the liabilities will remain outstanding. Moreover, it is quite possible, if we do see a stimulus bill at some point, that there would be another round of PPP loans, which could lead to at least another $100 billion to $200 billion of outstanding liabilities that debt managers would want to anticipate.

As for another fiscal support package, as of this writing, prospects look dim for an agreement in the near term. As a result, the odds of a package before the election seem low. However, even if nothing happens this month, there would still be a considerable chance of a deal after the election or, perhaps even after the new Congress and possibly new administration take office in January. Treasury debt managers would be in no position to let down their guard, even if there is no agreement in the near term.

Expecting persistent elevated cash balances

The Treasury’s cash balance has run at least double the stated target of Treasury debt managers for over three months. There will eventually come a time when it will be safe for them to allow the cash balance to run down, at which point, Treasury bill issuance would probably be able to drop substantially. However, there are good reasons to think that while Treasury debt managers may let the balance shrink in the fourth quarter, they will want to maintain at least some of their rainy day funds for the next few months.

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