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🌊 Is a huge wave of liquidity coming? The US will officially hit the debt ceiling on Tuesday. And the Treasury may be forced to drain the Treasury General Account. This could mean a big liquidity injection into markets - but it's not that simple. Here's everything I'm thinking about (WARNING - long post)... 🍽️ Let's set the table The US Government will hit its self-imposed "debt ceiling" of $36 trillion on Tuesday January 21. This means the Treasury can no longer take on additional debt until a new debt ceiling agreement is reached (this has historically involved raising or suspending the ceiling). But this doesn't mean imminent default. The Treasury has "extraordinary measures" that it can use, until lawmakers eventually agree to a new debt ceiling deal. One of those measures is to dip into the Treasury General Account (TGA) - the Government's bank account at the Federal Reserve. The TGA balance is currently a sizeable $650bn. When the Government uses cash from the TGA to fund spending, this is effectively an injection of liquidity into markets. This is because, when money is sat idle in the TGA at the Fed, it is "removed" from markets. But when it is spent down, it is released back into markets - an injection of "new" liquidity. In the past, significant TGA drawdowns have generally coincided with asset price appreciation. The TGA drawdown in 2022/2023 started halfway through a bear market, and was arguably one the main factors in halting that bear market. Some people even argue that debt ceiling episodes and TGA drawdowns have an even greater impact on asset prices than Quantitative Easing, because there is also no new net debt issuance for the duration of the debt ceiling talks. In recent years, debt ceiling episodes have always led to extensive and protracted discussions among lawmakers about what to do next - meaning the TGA has been drained close to zero, before a new deal is finally reached at the last minute. So, the short and dirty explanation of what might happen in the current situation is: 1. Debt ceiling debates are always protracted 2. Which means Treasury will be forced to draw down the TGA imminently 3. Which means an imminent and significant liquidity injection But it's not as simple as that. There are a number of nuances and considerations to be aware of: 1⃣ Will debt ceiling talks be protracted? The debt ceiling debate has previously been used as a political tool, with lawmakers making a stand on raising or suspending the ceiling, either for ideological reasons, or as a bargaining tactic to get something else that they want. This typically means disruptive lawmakers will hold out until the last minute, before ultimately agreeing to a new deal. In recent years, it has been used as a weapon by a Republican Congress against Democratic presidents. But this time, following the red sweep in November, any potential dispute is likely to be Republican vs Republican. This could potentially make protracted debt ceiling wrangling less likely than previously. However, there is a cohort of Republicans that have very strong feelings about the ballooning US debt situation, and it is a topical issue currently - they might want to puff their chests out and grandstand on the topic (before inevitably ultimately agreeing to a new deal). A super "tin-foil hat theory" is that Republicans may want to purposely drag out debt ceiling negotiations to achieve a full TGA drain in an attempt to start the new administration with a strong stock market. But I don't really buy that theory. 2⃣ So what in the world does "extraordinary measures" mean? "Extraordinary measures" are a set of tools, essentially financial maneuvers, available to the Treasury when the debt ceiling has been hit. One of those tools is draining the TGA, but it is one of many. It is currently looking likely that the Treasury will attempt to use some other measures, such as suspending investments in certain government accounts, before eventually turning to drawing down the TGA. In the latest letter penned by outgoing Treasury Secretary Janet Yellen, she writes that the Treasury’s extraordinary measures should begin by redeeming a portion of, and suspending full investments in, the Civil Service Retirement and Disability Fund. It is also planned to suspend additional investments of amounts credited to the Postal Service Retiree Health Benefits Fund. If the Treasury uses all other extraordinary measures available to it before drawing down the TGA, this might mean any potential TGA drawdown is delayed by between one and two months. 3⃣ Overall liquidity effects may not be so simple If a TGA drawdown occurs, there will simultaneously be a "negative net issuance" of Treasury bills. This may incentivize Money Market Funds, starved of new T-bills, to park cash in the Fed's Reverse Repo facility, which is effectively a liquidity drain. So it might be the case that there could be a sort of "push and pull" dynamic between a TGA drawdown (liquidity injection) and Reverse Repo usage increasing (liquidity drain). I don't know to what extent increased Reverse Repo usage may blunt the effects of any potential TGA drawdown from a liquidity perspective. However, if you are following along with the Net Fed Liquidity chart that I often post on X, this push and pull dynamic will be reflected in that chart, showing the total "net" liquidity injection (or drain). 4⃣ If drawn down, the TGA will eventually have to be refilled The final point is that, should the TGA be drawn down in any meaningful way, it will then need to be refilled once a new agreement is reached. This has the opposite effect, sucking liquidity out of markets (liquidity drain). TGA drawdowns are a big liquidity injection - but only temporary. 🔮 Let's look into the crystal ball Here's a very, very sketchy prediction of what might happen (likely to be wrong): Let's assume that debt ceiling wrangling among is lawmakers is protracted, despite the Republican vs Republican dynamic. 1⃣ The TGA balance will increase to a high of around $750bn to $800bn by the end of January due to seasonal factors (liquidity drain). 2⃣ A TGA drawdown of up to $800bn will then begin between roughly the middle of February and the middle of March (liquidity injection), after other "extraordinary measures" are exhausted. 3⃣ This TGA drawdown will then be "halted" temporarily by a big tax payment season in April, filling the TGA back up (liquidity drain). 4⃣ Then the drawdown will continue again (liquidity injection) and the TGA balance will continue to dwindle towards zero until some point in the summer, when a new deal will eventually be reached (at the last minute, as usual). 5⃣ During this roughly six month period, Reverse Repo usage might increase (liquidity drain), but not enough to fully mitigate the TGA drain (liquidity injection).

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