Debt Ceiling In March Unlikely To Repeat 2017 US Treasury Cash Deluge

Debt ceiling USD liquidity arithmetic

On 1 March 2019, the current debt ceiling suspension is due to expire. As seen on previous occasions, most recently in 2017, this is likely to be followed by a period where the debt ceiling binds and the US Treasury has to rely on extraordinary measures to fund the government. This time around, extraordinary measures will probably last around five-six months before a solution will need to be found, which is likely to be another suspension. The upcoming mid-term elections should not be a decisive factor in this progress.

In 2017, the end of the debt ceiling suspension provided a boost to USD liquidity as the US Treasury had to draw down its cash balance close to zero and in turn, it became a market mover for the USD money market and among other things led to a tightening of the 3M (NYSE:) OIS basis. We do not expect a similar development this time around. First, since the US Treasury will only have to draw its cash balance down to USD200bn (the level it was at when the debt ceiling was suspended and, coincidentally, the level it has normally been at on 1 March (Chart 2)). Second, the boost to liquidity will be mitigated by the Fed’s balance sheet reduction.

In comparison, USD liquidity rose more than USD60bn between the end of September 2016 and March 2017. An optimistic estimate would suggest that it could fall around USD70bn between end-September and March next year (Chart 1). It could be higher, e.g. if the debt ceiling increases the use of reverse repos again (Chart 3). The market is currently pricing in the 3M EURUSD OIS basis to return to the level from mid-2018 when the debt ceiling arrives next year (chart 4). With tighter USD liquidity, there is a risk that the market is pricing the basis too tight.

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