US borrowing binge risks market strains, analysts warn

Unlock the Editor’s Digest for free

Roula Khalaf, Editor of the FT, selects her favourite stories in this weekly newsletter.

The US will be forced to fund a massive increase in its budget deficit with short-term debt, analysts have said, with consequences for money markets and the battle against inflation.

The Congressional Budget Office, the independent fiscal watchdog, this week said aid packages for Ukraine and Israel would help push up the US deficit this fiscal year to $1.9tn — compared with its February prediction of $1.5tn.

“We are spending money as a country like a drunken sailor on shore for the weekend,” said Ajay Rajadhyaksha, global chair of research at Barclays. 

The increase in the deficit has long alarmed fiscal hawks, who warn the US’s lack of discipline will inevitably push up borrowing costs and that neither President Joe Biden nor his Republican challenger Donald Trump have substantive plans to shore up the country’s finances.

The more recent shift to short-term financing may also disrupt money markets and complicate the anti-inflation drive of the US Federal Reserve.

Some of the expected increase in the deficit is because of student loan forgiveness, which is not expected to have an immediate effect on cash flows.

But Jay Barry, co-head of interest rate strategy at JPMorgan, said the expanded deficit would require the US to issue an additional $150bn of debt in the three months before the fiscal year ends in September.

He added he expected most of the funds to be raised through Treasury bills, short-term debt instruments whose maturity ranges from one day to a year.

Such a move would increase the total outstanding stock of Treasury bills — unredeemed short-term US debt — from $5.7tn at the end of 2023 to an all-time high of $6.2tn by the end of this year.

“It is likely that the share of Treasury bills as a share of total debt increases, which opens up the question of who is going to buy them,” said Torsten Slok, chief economist at Apollo. “This absolutely could strain funding markets.”

The size of the Treasury market has quintupled since the financial crisis, in an indication of how much the US has turned to debt financing over the past 15 years.

As the deficit has risen, the US Treasury has found it increasingly hard to finance via long-term debt without causing an uncomfortable rise in borrowing costs. It has boosted the share of short-term debt it issues — but analysts warned it risks hitting the limits of demand.

Longer-dated Treasury auctions are at record sizes at some maturities, and questions about who will buy all the debt on offer have plagued economists and analysts for months.

Money market funds — mutual funds that invest heavily in short-dated debt — remain big investors in Treasury bills.

But worries about overall demand are greater, because the Fed, the largest owner of US Treasury debt, is pulling back from the market, fundamentally changing the balance between buyers and sellers of US bonds.

Analysts warn that if the US floods the market with Treasury bills, it could jeopardise quantitative tightening, the Fed’s drive to shrink its balance sheet, which is one of the main struts of the central bank’s push against inflation.

“The risk is QT is going to have to end sooner than expected,” said JPMorgan’s Barry. 

The Fed had to step into the markets during the so-called repo crisis of September 2019, when a dearth of buyers briefly sent overnight lending rates above 10 per cent.

Rajadhyaksha at Barclays warned the US could again experience “a September 2019 moment”.