US borrowing frenzy risks causing market stress, analysts warn

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The United States will be forced to finance a massive increase in its budget deficit with short-term debt, analysts say, with consequences for money markets and the fight against inflation.

The Congressional Budget Office, the independent budget watchdog, said this week that aid packages to Ukraine and Israel would help push the U.S. deficit this fiscal year to $1.9 trillion, compared with to its February forecast of $1.5 trillion.

We spend money as a country like a drunken sailor going ashore for the weekend, said Ajay Rajadhyaksha, global president of research at Barclays.

The rising deficit has long alarmed fiscal hawks, who warn that America's lack of discipline will inevitably drive up borrowing costs and that neither President Joe Biden nor his Republican challenger Donald Trump has substantial plans to consolidate the country's finances.

The more recent shift to short-term financing could also disrupt money markets and complicate the U.S. Federal Reserve's anti-inflationary campaign.

Part of the expected increase in the deficit is due to student loan forgiveness, which is not expected to have an immediate effect on cash flow.

But Jay Barry, co-head of interest rate strategy at JPMorgan, said the rising deficit would force the United States to issue an additional $150 billion in debt in the three months before the end of the fiscal year in September.

He added that he expected most of the funds to be raised through Treasury bills, short-term debt instruments with maturities ranging from one day to one year.

Such a move would increase the total outstanding short-term U.S. debt outstanding Treasury bills from $5.7 billion at the end of 2023 to a record $6.2 billion by the end of this year.

The share of Treasuries in total debt is likely to increase, raising the question of who will buy them, said Torsten Slok, chief economist at Apollo. This could absolutely strain financing markets.

The size of the Treasury market has quintupled since the financial crisis, reflecting the extent to which the United States has turned to debt financing over the past 15 years.

As the deficit grew, the U.S. Treasury found it increasingly difficult to finance itself through long-term debt without causing an uncomfortable rise in borrowing costs. It has increased the share of short-term debt it issues, but analysts have warned this risks reaching demand limits.

Auctions of longer-term Treasury securities are reaching record sizes for some maturities, and questions about who will buy all the debt on offer have plagued economists and analysts for months.

Money market mutual funds that invest heavily in short-term debt remain big investors in Treasuries.

But concerns about aggregate demand are greater as the Fed, the largest owner of U.S. Treasury debt, withdraws from the market, fundamentally changing the balance between buyers and sellers of U.S. bonds.

Analysts warn that if the United States floods the market with Treasuries, it could undermine quantitative tightening, the Fed's drive to reduce its balance sheet, which is one of the main ways central banks fight against inflation.

The risk is that QT may have to end sooner than expected, JPMorgans Barry said.

The Fed had to intervene in the markets during the so-called repo crisis of September 2019, when a shortage of buyers briefly pushed overnight lending rates above 10%.

Barclays' Rajadhyaksha warned that the United States could once again experience a moment similar to that of September 2019.

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