Bond Dealer Limits to Exacerbate Cost Impact of T-Bills Deluge

(Bloomberg) — It’s not only yields that are set to be impacted as the US Treasury ramps up the supply of bills, according to interest-rate strategists at Barclays Plc.

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While they expect bill supply to increase by another $800 billion by year-end, cheapening yields on a range of short-term investments by at least 5 to 10 basis points, the sheer volume of bills will also test dealers’ ability to operate in related markets — at a time when they face regulatory pressure to retreat. That, in turn, could increase the the cost of borrowing dollars globally.

In particular, cross-currency basis swaps — the cost of swapping euros and yen for dollars, the world’s preferred currency in times of stress — are likely to widen if dealers become constrained, Barclays strategists including Joseph Abate said in a report.

Bill supply purchased by dealers “could reduce dealers’ capacity to intermediate between borrowers and lenders in the cross-currency and unsecured markets, which could, in turn push rates higher,” they wrote.

In the minutes from the Fed’s June 13-14 meeting released Wednesday, a few participants noted there could be some upward pressure on money-market rates in the near term as Treasury issued more bills to replenish its cash balance.

The increase in bill supply since US lawmakers agreed to suspend the debt limit in early June appears to be finding a home. But evidence is emerging that dealers are running short of space.

Treasury-backed repo transaction volume is up 10% since December, and a surge in sponsored-repo activity suggests balance-sheet capacity is becoming scarce, Abate wrote. At the same time, the annual systemic risk scores for global systemically important banks, or GSIBs appear likely to rise.

In 2022, banks started paring repo and cross-currency basis activity in the second and third quarters in order to avoid higher GSIB scores, and that “risk dieting” could be more pronounced this year, according to Abate.

As of the first quarter, there were four banks within 25 basis points of a higher capital buffer. Reducing activity in these markets helps lower the size, cross-border and complexity components included in the total calculation.

Potentially making matters worse: the Federal Reserve’s effort to shrink its balance sheet is forecast to drain reserves from the banking system, causing banks to have to pay more for deposits.

Bank unsecured borrowing rates “may rise by more than the increase in bill yields as bank reserves fall,” the Barclays strategists wrote.