The Treasury’s cash pile is a “wildcard” with a new administration

(Bloomberg) — A change in leadership at the U.S. Treasury is likely to change how the department deals with the cash it parks at the Federal Reserve, and strategists are warning of implications that could affect the nation’s debt market.

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Bank of America Corp. and Wrightson ICAP LLC are among the companies that say the Treasury could keep less money in its account at the Fed as it shrinks its cash balance, a reserve of funds to ensure the U.S. can always pay its bills . This would allow the government to sell less short-term debt and potentially save taxpayers money now that the debt ceiling has been reset and the cash pile is shrinking. The balance is expected to continue to decline until the debt limit is lifted or suspended again.

The breakdown of the composition of the Treasury debt load between bills and coupon securities, which has remained stable in recent quarters, was a central point during President Donald Trump’s election campaign, with many prominent voices going criticize former Treasury Secretary Janet Yellen for issuing too many Treasury bills.

“The new Treasury team is likely to reconsider the large precautionary cash reserve policies of recent years,” Wrightson ICAP chief economist Lou Crandall said in an interview on Friday. “I do not believe that the United States would face serious operational risks if it reduced its cash balance to previous rules, and this action could also delay the Treasury from having to make any adjustments to the size of the coupon debt auction if it wanted to reduce the issuance of invoices”.

Scott Bessent, who is now awaiting confirmation to lead the department, was among those who argued that the decision to rely on short-term debt to finance the deficit hurt the economy by sending long-term rates lower , a charge that Treasury Yellen rejected.

The possibility of a Bessent-led Treasury signaling an intention to lower its cash balance target could come next month when US debt managers meet for their quarterly debt repayments, Bank strategists say of America Mark Cabana and Katie Craig.

The cash balance in the Treasury’s general account at the Fed was $665 billion as of Jan. 22, according to Treasury data released Thursday. That’s down from April’s peak of $962 billion and below last year’s average of about $748 billion, the data show.

In 2015, the Treasury instituted a policy of keeping at least five days of spending, or a minimum of $150 billion, in the account in case unexpected disruptions shut it out of debt markets. Before that, he kept enough cash for just two days. But as budget deficits began to soar, the size of that cushion has grown. Outstanding US Treasury debt has soared to more than $28 trillion from about $13 trillion at the end of 2015.

Even adjusting the cash balance by a few billion would allow the department to sell fewer tickets, removing some upward pressure on rates. That could also allow the Federal Reserve to hold onto its balance sheet longer, according to Wrightson and Bank of America.

The central bank has reduced its holdings of government securities by more than $2 trillion since unwinding, a process known as quantitative tightening, began in mid-2022.

Strategists at Barclays Plc and Bank of America recently pushed back their QT-end forecasts to September instead of March, citing moderate volatility in funding markets and the Fed’s lack of communication on balance sheet plans .

Further clouding the outlook for both short-term Treasury debt issuance and Fed easing is the reappearance of the debt ceiling, which was reset earlier this month.

A more extensive episode under this constraint will force the government to reduce the supply of bills and use up its cash pile. In turn, this will artificially increase central bank liabilities, masking the money market signals about liquidity that are used to gauge when it is time to stop QT.

Moreover, once the debt limit is resolved, the reversal of Treasury balances and bank reserves could be abrupt, although a smaller government cash pile could minimize volatile changes in the Fed’s liabilities and money market rate.

The last time the Treasury addressed the cash balance was in February 2022, when it articulated how it measures the size of the cushion.

Officials, as part of the quarterly briefing, noted that the Treasury develops its borrowing plans by evaluating cash flow projections for the coming weeks and months, resulting in a cash balance target above of the level seen for a week.

All in all, changes in cash balance policy are likely to be felt outside of Washington and force a recalibration for fixed income investors.

“The US Treasury cash balance is a wild card with the change in administration,” Bank of America’s Cabana and Craig wrote in a note this week.

While the Treasury Borrowing Advisory Committee can advise on the cash balance and Congress has oversight, it defers policy to the Treasury secretary, and the new secretary could reduce the cash pile as a means of cutting costs , they said.