An agreement on the US debt ceiling has been reached, but the stalemate of the past few months has taken a toll on the Treasury’s coffers. As explained in the first article in the series, ‘US debt: Where from here?’, the American government will need to replenish its funds by issuing a significant amount of Treasury securities in a matter of months. It is estimated that between $600 and $700 billion will need to be raised to replenish government coffers, along with an additional $500 billion to cover current state spending. This is a substantial sum to recover, and there are concerns that it could create stress in the market. There are two parties who could purchase the debt: banks on one side and money market funds on the other. In the second article of this series, we analysed what would happen if banks were to buy the majority of the debt, while here we will delve into the theory that money market funds are the main buyers of US debt.
Would money market funds defuse the liquidity problem?
Money market funds invest in both short-term debt securities and the famous Reverse Repo Facility (RRP), a mechanism that allows them to lend money overnight to the Federal Reserve in exchange for short-term Treasury securities. An important aspect, especially regarding US debt, is that the money invested in the RRP does not enter the economic system. Therefore, if money market funds were to purchase US debt, there would be no direct impact on the liquidity of the financial system.
Currently, money market funds have over $5 trillion invested in various assets. In the Reverse Repo facility alone, they have over $2.1 trillion invested, a sum sufficient to cover the government’s needs. If money market funds were to decide to shift their investments from the Reverse Repo facility to short-term Treasury securities, the liquidity repercussions would be minimal, as these funds are already ‘parked’ with the Fed overnight.
The uncertainty in this case is whether these funds will actually want to buy the Treasury securities. No decision, especially in finance, is made without economic returns in mind. In this case, we are talking about yields. So far, the government has managed to convince funds to shift their money towards US debt by paying a rate of 5.09%. However, this percentage will need to increase if the Treasury wants to further encourage massive purchases of Treasury securities by the funds. If the Treasury were to issue securities with a yield below what is currently guaranteed by the Reverse Repo Facility, it is highly likely that money market funds would not readily embrace buying US debt. In that case, the issue would be transferred to the banks, resulting in a decrease in their reserves and liquidity in the market.
The situation is not easily resolvable for the US Treasury. We will continue to monitor the situation closely and keep you updated on the latest developments in the American market.
*As with all investing, financial instruments involve inherent risks, including loss of capital, market fluctuations and liquidity risk. Past performance is no guarantee of future results. It is important to consider your risk tolerance and investment objectives before proceeding.