Analysts warn that US borrowing glut risks weighing on markets

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Analysts say the United States will be forced to finance a large and growing budget deficit with short-term debt, with implications for financial markets and the fight against inflation.

The Congressional Budget Office, an independent fiscal watchdog, said this week that aid to Ukraine and Israel will increase the U.S. budget deficit this fiscal year to $1.9 trillion, up from a $1.5 trillion forecast in February.

“Our country is spending like a drunk sailor who’s gone ashore for the weekend,” said Ajay Rajadhyaksha, global research chairman at Barclays.

The growing deficit has long alarmed fiscal hawks, who warn that a lack of U.S. discipline will inevitably drive up borrowing costs and that neither President Joe Biden nor his Republican opponent Donald Trump have a substantive plan to shore up the country’s finances.

The recent shift to shorter-term funding could also roil financial markets and complicate the Federal Reserve’s efforts to combat inflation.

Part of the projected deficit increase will come from student loan forgiveness, which is not expected to have an immediate impact on cash flow.

But Jay Barry, head of interest rate strategy at JPMorgan, said the widening budget deficit will mean the U.S. will need to issue an additional $150 billion in debt in the three months to the end of the fiscal year in September.

He added that he expects most of the funding to be raised through Treasury bills, which are short-term debt securities with maturities ranging from one day to one year.

These moves will increase the outstanding balance of Treasury bills, or short-term U.S. debt securities, from $5.7 trillion at the end of 2023 to a record $6.2 trillion by the end of this year.

“The share of Treasury bills in total debt is likely to increase, which raises the question of who will buy them,” said Torsten Slok, chief economist at Apollo. “This could definitely put a strain on funding markets.”

The size of the Treasury market has expanded fivefold since the financial crisis, showing how much the United States has relied on debt financing over the past 15 years.

As the budget deficit has grown, the U.S. Treasury has found it increasingly difficult to raise funds with long-term debt without incurring an unpleasant rise in borrowing costs. It has been issuing a higher proportion of short-term debt, but analysts warn it risks hitting a demand limit.

The long-term bond auctions are reaching record sizes for some maturities, and the question of who will buy all of the bonds being auctioned has dogged economists and analysts for months.

Money market funds, which are mutual funds that invest heavily in short-term securities, remain big investors in Treasury bonds.

But there are bigger concerns about overall demand as the Fed, the largest holder of Treasury securities, withdraws from the market, fundamentally changing the balance between buyers and sellers of Treasury securities.

Analysts have warned that if the United States floods the market with Treasury bonds, it could jeopardize the Fed’s quantitative tightening policy, one of its main tools for fighting inflation, which is to reduce its balance sheet.

“There’s a risk that QT will end sooner than expected,” JPMorgan’s Bury said.

During the so-called repo crisis in September 2019, the Fed was forced to intervene in the market after a lack of buyers caused overnight lending rates to briefly exceed 10%.

Barclays’ Rajadhyaksha warned that the US could experience another “September 2019-like moment.”