Opinions, estimates, forecasts, projections and statements of financial market trends are based on market conditions at the date of the publication, constitute our judgment and are subject to change without notice. There can be no guarantee they will be met.
09 June 2023
Done with the debt ceiling drama, now onto the TGA
With the US debt ceiling crisis behind us, we ask what the draining of the Treasury General Account (TGA), and its needed replenishment, could mean for the US economy and for fixed income investors.
Fundamentals
The TGA is the account at the Federal Reserve (the Fed) that the US Treasury uses to pay the country’s bills, funded by tax receipts and the sale of US Treasury debt. The Treasury generally strives to maintain a balance in the TGA “to cover one week of net outgoing payments”, subject to a minimum of ~$150 billion. Due to the debt ceiling chaos, the TGA was run down to a balance of $49 billion (as of 31 May 2023). With the Treasury expecting to bring the balance back up to $600 billion by the end of September, some analysts estimate it could take about $850 billion in net Treasury bill (T-bill) issuance over the four-month period to make good the shortfall. Importantly, the TGA sits on the Fed’s balance sheet as one of three large liabilities, along with bank reserves and reverse repurchase agreements (RRPs). Considering that the Fed is currently in a phase of quantitative tightening and is not expected to be a large buyer of these new T-bills, the replenishment of the TGA needs to be balanced by either a drain in banks’ excess reserves or out of RRPs. Draining banks’ reserves at the Fed can create a problem in the financial system, reducing liquidity and subsequently the ability of banks to lend. The question for the market is how much of this T-bill issuance will be bought by money market funds switching out of cash deposited with the Fed’s RRP facility. The lower the take-up from money market funds, the more likely the TGA rebuild will need to be offset by a fall in banks’ excess reserves. As excess reserves are not distributed uniformly across the banking system, the risk is that a tightening in financial conditions could spark poor performance in risk assets, similar to that seen in late 2018.
The TGA needs to be rebuilt, which could potentially have an impact on reserves and subsequently risk assets
Source: Bloomberg, Federal Reserve; data as of 31 May 2023.
Quantitative Valuations
The bond market has repriced, with yields rising in the past few weeks. The two-year Treasury yield, at 4.56% as of 7 June, reflects the market’s expectation of one more 25 basis points (bps) rate hike from the Fed in July. The first 25bps rate cut is now expected by December, with the second cut in late spring 2024. Should the TGA rebuild be offset by a sharp fall in banks’ reserves at the Fed and a tightening in broader financial conditions, the bond market is likely to move to price in a faster cutting cycle, which would be consistent with falling bond yields.
Technicals
The yield on the three-month T-bill, at 5.29% as of 7 June, is currently attractive compared to the 5.05% yield on the Fed’s RRP facility. However, the duration of the three-month T-bill is much longer than the overnight duration of RRPs. Demand for T-bills from money market funds will therefore depend on the willingness of money market funds to extend duration. With the market currently pricing a 33% chance of a June rate hike (as of 7 June), and with almost a full 25bps hike priced in for July, next week’s US inflation data and the Fed’s rate setting meeting will be key for giving money market fund managers comfort that the Fed is near the end of its hiking cycle.
What does this mean for investors?
While the impact of the TGA rebuild on both financial markets and the real economy remains uncertain, we believe that funding the TGA out of the Fed’s reserves could spark a risk-off market environment. Additionally, while a recession remains the market’s consensus view, there is no consensus on the timing. In this environment, we continue to favour a longer duration, higher quality fixed income allocation as the positive carry remains appealing. On the currency side, we expect the TGA rebuild to be positive for the US dollar.
About the Bond Bulletin
Each week J.P. Morgan Asset Management's Global Fixed Income, Currency and Commodities group reviews key issues for bond investors through the lens of its common Fundamental, Quantitative Valuation and Technical (FQT) research framework.
Our common research language based on Fundamental, Quantitative Valuation and Technical analysis provides a framework for comparing research across fixed income sectors and allows for the global integration of investment ideas.
Fundamental factors
include macroeconomic data (such as growth and inflation) as well as corporate health figures (such as default rates, earnings and leverage metrics)
Quantitative valuations
is a measure of the extent to which a sector or security is rich or cheap (on both an absolute basis as well as versus history and relative to other sectors)
Technical factors
are primarily supply and demand dynamics (issuance and flows), as well as investor positioning and momentum
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