Debt Ceiling Talks Continue as Treasury Balances Dwindle

Debt Ceiling Talks Continue as Treasury Balances Dwindle

• Markets are somewhat calm this morning as traders believe a debt ceiling deal will be had, despite little in the way of outright optimism expressed by the leading actors in this saga. We think cooler heads will eventually prevail but only at the 11^th hour and we are not there yet. And speaking of the 11^th hour, that could be a moving target which we discuss in more detail below.  In any event, the 10yr is currently yielding 3.52%, up 2/32nds in price while the 2yr is yielding 4.09%, unchanged on the day.

• As the debt ceiling dance continues, some troubling news on the Treasury front has appeared. Outflows from the Treasury’s General Account (essentially their checking account) totaled $52 billion with the balance standing at $87 billion. Wrightson ICAP, which is expert at assessing such things, had this to say about the Treasury’s cash position: “The prospects for avoiding a June X-date worsened after the Daily Treasury Statement for May 15 was released yesterday. The Treasury’s cash balance on Monday came in $15 billion below our day-ahead forecast. Our guess is that roughly half of the cash flow miss will end up being offset by an increase in Treasury debt ceiling headroom relative to our earlier forecasts, which will give the Treasury some additional flexibility in managing its cash position in the first half of next month. The bottom line, though, is that the cash shortfall is greater than the likely pick-up in borrowing capacity.”   Maybe those doing the debt negotiating should touch base with the Treasury on those TGA balances.
• Circling back to that issue, as the Treasury has drawn down its TGA balances in this period of “emergency measures” its acted as something of an offset to the Fed’s QT program. That is, it’s been releasing reserves from the TGA back into the banking system which offsets somewhat the Fed’s shrinking balance sheet that is draining reserves from the banking system at the same time. So, assuming the debt ceiling is eventually raised, and the Treasury can issue more debt, it will use much of the early proceeds to rebuild its TGA account, effectively removing reserves from the system. Then it will be working in concert with the Fed’s QT program and not against it.
• Thus, once a debt deal is done the impact of the Fed’s QT program will no longer be blunted and tightening in financial conditions will increase. It’s one of the oddities coming from this debt ceiling dance that hasn’t gotten much notice but it’s likely to be felt in the summer, assuming a deal is done. Look for more chatter on this in the weeks and months ahead.

• Meanwhile, housing starts in April were released this morning and came in at 1.401 million vs. 1.400 million expected but the prior month was revised down to 1.371 million from 1.420 million. Building permits disappointed at 1.416 million vs. 1.430 million expected but March was revised higher to 1.437 million from 1.413 million. So, a mixed read on housing activity which the market has largely shrugged at what with the debt ceiling saga stealing all the attention.

• Relatedly, as mortgage rates hit two-month highs purchase applications fell 4.8% in the week ended May 12, the lowest level in a month. The contract rate on a 30-year fixed mortgage increased 9 bps to 6.57%, the highest since mid-March. So once again the potential home buyer seems to shy away as mortgage rates climb above the 6.25% – 6.50% range.

MBA Average 30yr Fixed Rate Mortgage Rate

Agency Indications — FNMA / FHLMC Callable Rates