The Debt Ceiling Impasse Has Meant Mini QE Since May – Will Mean QT When Resolved

When the US government gets near its statutory debt limit, congress must lift the debt limit in order for the Treasury to continue to issue debt to pay for government expenses. Simple enough. However, even after the debt limit is reached, the Treasury can use “extraordinary measures” so that the government can keep paying its various agencies and service providers. “Extraordinary measures” is really just the Treasury drawing down its checking account at the Fed, the same way an individual would draw down their checking account if they were between jobs.

The act of the Treasury drawing down its account at the Fed is kind of like a mini version of quantitative easing in that it adds liquidity to the system that otherwise would not have been there. So far the Treasury has drawn down its checking account at Fed by a cool $200bn since May, or $100bn per month.

On the flip side, when the debt ceiling impasse is finally settled, and it looks like that is going to happen any day now per Treasury Secretary Mnuchin’s comments, the Treasury will need to build back up its checking account balance at the Fed. This means issuing enough debt over the next few months to not only cover ongoing expenses, but also enough to add back the $200bn it has withdrawn from its checking account so far. The extra issuance of debt is kind of like quantitative tightening in that it removes liquidity from the system.

I would suggest that removing liquidity from the system at a time when growth is likely to be slowing anyways, as we showed here, will add an extra layer of risk to liquidity sensitive assets over the next few months.

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