(Bloomberg) -- Money-market traders are starting to get nervous that the debt-ceiling battle will go down to the wire, even though the U.S. government has created some breathing room for now.
Forty-six Republican senators signed a letter indicating they won't vote for an increase in the debt limit -- a move that could risk the Treasury defaulting on its obligations as soon as next month. In addition, the Democrats' $3.5 trillion budget resolution didn't include the cap. As a result, Treasury bills maturing in October and November -- which align with the Congressional Budget Office's estimates -- have cheapened relative to the rest of the short-end curve.
The latest drama is likely to further rankle short-term funding markets that are already bogged down by an abundance of cash chasing just a few assets. These imbalances are likely to continue as the Treasury exhausts its cash buffer and removes more bill supply from the market in order to free up room under the cap.
“Looks like there's going to be another fight about this political ‘hot potato,'” said Gennadiy Goldberg, senior rates strategist at TD Securities.
The Treasury has started using extraordinary measures this month to help finance the government, saying Aug. 4 that it's not able to provide a specific estimate of how long they will last. The department also plans on ending weekly issuance of six-week cash management bills after settlement on Aug. 19, which will also give the government more room for maneuver.
Funding-market distortions will also continue to boost demand for the Federal Reserve's overnight reverse-repo facility, in which counterparties like money-market funds can place cash with the central bank to earn 0.05%. On Wednesday, 70 participants parked $1 trillion at the Fed, the second-highest of all time and just shy of the $1.04 trillion on July 30.
In addition to the “specific mispricings” of Treasuries around the anticipated drop-dead date, the further bill paydowns and decline in the cash balance will flatten the front-end of the bill curve toward zero, and soften rates on repurchase agreements, RBC Capital Markets strategist Blake Gwinn wrote in an Aug. 10 note to clients.
“I expect GOP will be in scorched Earth mode this fall,” he said, referring to the Republicans.
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