A Treasury Bill Deluge Is Here. What Could Go Wrong.

The Treasury Department wants to take its cash account to about $500 billion by the end of July. (Al Drago/Bloomberg)

The Treasury Department is issuing billions of short-term debt and Wall Street is keeping a close watch on whether it trips a fuse in the funding market.

No trouble is expected in the near-term—but beyond that, worries loom.

The Treasury issues debt every week that expires in under a year. It recently boosted that amount, adding $25 billion each to its 4-week and 8-week bill auctions on Thursday compared with the prior auction on July 3.

The department is trying to replenish its cash buffer, which was depleted while it waited for Congress to lift the Treasury’s borrowing limit. Its account dwindled to $313 billion on July 3—about half the amount versus a year ago—before the debt limit was increased by $5 trillion.

The Treasury now wants to take its cash account to about $500 billion by the end of July, and around $850 billion by the end of September, according to its statement on July 8.

Much of that will come from T-bills. Barclays expects $410 billion worth of bills issued over this current third quarter while J.P. Morgan expects $629 billion. Deutsche Bank predicts about $500 billion. To put it in context, the Treasury issued a net $511 billion bills in all of 2024.

Why It Matters

The Treasury risks tipping the market to a point where it doesn’t have enough liquidity to absorb all the debt.

One gauge of excess liquidity is the Federal Reserve’s overnight reverse repo facility, or RRP. Money-market funds, such as those from Vanguard and other institutions, have $182 billion parked there, where they currently earn a rate of 4.25%.

As the Treasury floods the market with a competing asset—T-bills—money is expected to drain out of the RRP. And when the balance “gets very low, let’s say, 50 billion or so, then I would worry about where is the next leg of demand is going to come from,” Deutsche Bank strategist Steven Zeng told Barron’s.

The $3.3 trillion in U.S. banking reserves sitting at the Fed is the next source of demand for the T-bills, but a sharp decline in reserves is something the market cannot afford. In 2019, when the balances sank, there was an abrupt dislocation in the funding markets as the rate at which institutions borrowed from each other overnight, the so-called Secured Overnight Financing Rate, reached a record.

Economists and strategists have widely said there is no easy way to determine what bank reserve level would cause stress in financial markets, but stress in the market is something the Treasury wants to avoid. The department has said that it “will carefully monitor market conditions and adjust its issuance plans as appropriate.”

Angelo Manolatos, macro strategist at Wells Fargo pointed to recent small spikes in the Secured Overnight Financing Rate.

“We are already been seeing repo market pressure at month end- quarter-end settlement and tax dates as well,” Manolatos told Barron’s. “Its really going to be a test.”

The firm expects $700 billion in bills in the second-half of this year.

Another risk is that less cash at the RRP would mean the Treasury, at some point, would need to offer higher yields to attract money-market funds. This would increase the government’s borrowing expenses.

Relying more on the shorter-end also means the government is slowly opening itself to the whims of the market. If conditions become unfavorable, investors could demand more yield, which would also increase the government’s borrowing costs.

The Good News

Unlike previous debt ceiling sagas, the Treasury’s current bill issuance is more measured and gradual. Its cash account didn’t fall below $50 billion, and the debt limit has seen a larger-than-expected increase.

“[Treasury Secretary] Scott Bessent is very cognizant of not doing more than he needs to do. I mean, there’s no panic out there,” said Padhraic Garvey, the regional head of research for the Americas at ING.

Bills are also universally loved. Unlike stocks, T-bills offer security while yields above 4% look attractive. In the second quarter, investors poured $16.7 billion into exchange-traded funds that hold Treasury bills, more than double the amount seen in the same period last year.

In contrast, the SPDR S&P 500 fund and iShares 20+ Year Treasury Bond funds—the most popular stock and bond funds—saw money flow out of them in the second quarter.

“I don’t want to say I’m very relaxed about this,” Zeng said. “Its something that we are monitoring very carefully, but for now, we think the next couple of weeks were okay. It’s starting around, you know, maybe September and we would expect rates on pretty much everything we need to go up.”

Write to Karishma Vanjani at karishma.vanjani@dowjones.com.