The recent resolution of the U.Sdebt ceiling issue may have provided temporary relief, but it has also set the stage for substantial government bond issuance by the U.STreasury, raising concerns about potential liquidity siphoning effects on the treasury marketAs the Treasury prepares to float a significant number of bonds to replenish its cash balance and cover deficits, observers are left wondering whether this strategy will inadvertently lead to rising bond yields.

The situation has drawn attention to liquidity concerns in the treasury market following the lifting of the debt ceilingTo bolster the General Fund and address ongoing deficit expenditures, the Treasury plans to embark on a significant issuance of government bonds, particularly in the short-term segmentAmid the backdrop of the Federal Reserve's quantitative tightening (QT), this significant net increase in supply is poised to drain liquidity from the treasury market, possibly driving yields higher.

According to plans presented during the Treasury's refinancing meeting in May, the net supply of treasury bonds in the second and third quarters is expected to rise by approximately $1.46 trillion

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This increase aims to refill the Treasury General Account (TGA) balance, which was reported at merely $77.5 billion on June 7, while also covering routine deficit spending.

Within the projected $1.46 trillion of net supply, short-term treasury bills (with maturities ranging from four to fifty-two weeks) will account for the bulk, amounting to $1.05 trillionThis makes short-term securities the primary means of replenishing TGA funds, while medium to long-term bonds will contribute $407 billion to this figure.

Specifically, the Treasury forecasts that the net issuance in the second quarter (April to June) will be $4.78 trillion for short-term bills and $2.48 trillion for medium to long-term bondsFor the third quarter (July to September), the expected figures increase to $5.74 trillion and $1.59 trillion, respectively

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This translates to an average monthly issuance in the third quarter of approximately $1.91 trillion in short bills and $530 billion in medium to long-term securities.

Historically, the practice of issuing a large volume of short-term securities to replenish the TGA balance is unprecedentedThus, any comparison with previous instances of debt ceiling resolutions is not fully applicable in this context.

Drawing on historical data can provide contextLooking at past experiences, the net supply increases in medium to long-term bonds do not appear exceptional from a historical perspectiveSince the Federal Reserve initiated QT in 2022, the average monthly net increase has hovered around $86 billion, peaking at a monthly average of $143.9 billion in the second quarter of that year.

Examining short-term bills, two notable periods of significant net supply increases since 2010 can help provide perspective

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The first occurred in the second quarter of 2020, with a net increase of $1.34 trillion in April, followed by $628.1 billion in May and $449.7 billion in JuneThe second period was the early months of 2023, where net increases were recorded at $241.5 billion and $118.9 billion in January and February, respectively.

In April 2020, the rise in short-term treasury bill rates was modest, increasing by around 10 basis points during the week of April 13. Subsequently, rates returned to levels seen before the uptickSimilarly, during January and February 2023, short-term bill rates exhibited no marked fluctuation.

The broader overnight funding costs, represented by the Secured Overnight Financing Rate (SOFR), did not show any major changes during those two significant periodsThe median values of SOFR and the SOFR-SOFR spreads, representing financing costs for marginal financial institutions, remained stable, indicating that short-term liquidity was not under stress.

Opinions among traders about the potential interest rate impact of the increased short-term bond supply vary

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A neutral expectation stemming from a survey conducted at May's refinancing meeting suggested that a net increase of around $600 billion in short-term notes would not significantly affect market pricingSome traders, however, believe the potential net increase could reach $1 trillion.

Moreover, considering the TGA balance, the potential liquidity siphoning effect may be less than anticipated; estimates suggest it might only approach $500 billionWhile the current TGA balance is approximately $775 billion, projections indicate it would rise to about $5.5 trillion by the end of JuneThus, the actual impact on liquidity appears limitedFurthermore, throughout the third quarter, the TGA balance is expected to increase modestly, resulting in a relatively minor overall liquidity effect.

Current market fears regarding extensive short-term bond issuance draining liquidity are somewhat tempered by the surplus of available funds within the money market

The Fed's Reverse Repo Program (RRP) still maintains around $2.1 trillion in assets, primarily held by money market funds (MMFs). The adjustment of their asset allocation structures can absorb the new short-term bond supply; this outlook was reflected in discussions at the May refinancing meeting among traders.

Even if short-term liquidity were to become strained, primary dealers possess fallback options, such as leveraging the Standing Repo Facility (SRF) to access overnight loans from the FedUnlike the 2019 liquidity crunch in the repo market—triggered primarily by tax payments and treasury settlements—traders now have more tools available for short-term liquidity support.

In conclusion, while the U.STreasury's plan to issue a significant number of short-term bonds post-debt ceiling resolution raises legitimate liquidity concerns, the overall effects may be limited