This week, an important milestone was reached in the American financial system, as the reserves of the banking sector fell below the $30 trillion mark for the first time in four yearsThis dip has raised alarm bells among market analysts, prompting concerns over whether the Federal Reserve's ongoing quantitative tightening (QT) measures might trigger a liquidity crisisHowever, as the U.Sgovernment nears another confrontation with the debt ceiling limit, the nation’s financial markets are poised to witness both the influx of liquidity and the tightening of financial flows following the anticipated resolution of this fiscal challenge.

In a report released this past Thursday, Goldman Sachs' rates strategy head William Marshall expressed that the suspension of the debt ceiling is expected to end by early 2025. U.STreasury Secretary Janet Yellen has recently warned Congress leaders from both parties that should the debt ceiling be triggered, the Treasury might have to resort to extraordinary measures to prevent a default around mid-January, pending Congressional action to resolve the debt ceiling issue

Following this period, the next debt ceiling deadline is expected around July or August of 2025.

The General Account of the U.STreasury is essential for managing incoming tax revenue and government spending, essentially keeping the federal government operationalIn situations where the debt ceiling looms, the Treasury often relies on cash reserves within the Treasury General Account (TGA) and utilizes extraordinary measures to stall a potential defaultThe balance in the TGA directly influences the Treasury's ability to continue covering expenses until a new debt agreement is reached.

Marshall's report highlighted that Goldman Sachs predicted the TGA's balance would exceed $1 trillion at the inception of the new debt ceiling situationHowever, uncertainties remain regarding how the Treasury will manage available leverage—specifically how depleting TGA funds will compare with the pace of extraordinary measures stemming from increased net issuance of debt

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Historical data from between 2011 and 2023 shows a common trend: when a debt ceiling is in place, the supply of U.STreasury securities diminishes, leading to increased liquidity stemming from the declining TGA reserves.

Reflecting on more than a decade of records, it can be inferred that during the six months leading up to an agreement on the debt ceiling, the average supply of U.STreasury bonds tends to drop by about $130 billion, and TGA funds may decrease by roughly $225 billionConversely, the alterations after an agreement tend to manifest quicker, with the amount of outstanding public debt and TGA balances reverting to previous levels typically within one to two months.

When comparing the TGA balance during past instances of reaching the debt ceiling, such as the peaks seen in 2021 and 2023—around $450 billion—the current TGA situation indicates a much healthier stockpile

Goldman Sachs anticipates that this year’s TGA reduction will mirror the experiences of 2021 and 2023. The periods surrounding the reaching and resolution of the debt ceiling in those years saw a substantial TGA balance shrinkage of around $425 billion.

If the window before the upcoming deadline persists into the third quarter of 2025, the TGA could undergo a sharper decline, especially as July and August tend to symbolize high deficit months within the fiscal cycleGoldman Sachs speculates that in such a scenario, the repayment obligations in the initial two quarters could hover between $400 billion and $600 billion, mirroring repayment amounts from 2021.

Marshall advises that the limitation imposed by the debt ceiling signifies a notable reduction in the supply of U.Streasuries prior to the cementing of a debt agreement, whereas overall liquidity levels will surpass those seen in a scenario devoid of a cap.

Such a reduction in Treasury supply means that the Treasury may be compelled to dip into the TGA fund due to the inability to extend the maturity of U.S

bonds—at the same time, the liquidity tied to maturing treasuries will be redistributed to other risk assets, potentially boosting their values, even amid the looming specter of another crisisEffectively, periods leading up to the debt ceiling deadline have historically proven advantageous for risk assets, not because markets overlook impending political conflicts, but rather due to a surge in overall liquidity.

As the Federal Reserve continues with its quantitative tightening strategy, Goldman Sachs forecasts a lesser increase in aggregate liquidity within the financial system—its estimation accounts for the growth of cash reserves within banks and reverse repo (RRP) toolsUnder the assumption that the debt ceiling agreement remains unachieved by mid-2025, the projected liquidity growth would be about $150 billion to $250 billion.

Should the TGA notice a more significant and prolonged decrease extending into the latter half of the year, liquidity growth could surpass 2023 levels

Conversely, if the QT and/or the concluding timeline extends beyond Goldman Sachs’ mid-2025 baseline expectations, any potential liquidity growth will be suppressedDespite anticipations for aggressive action from the Federal Reserve to boost overall liquidity, Goldman Sachs believes such situations are unlikely materializationsUltimately, in the absence of any debt ceiling constraints, the supply of U.STreasury securities will remain relatively stable while the system's overall liquidity is reduced by approximately $350 billion in the first half of the year.

This scenario indicates that the Treasury's TGA balance is notably robust compared to previous instances of reaching the debt ceilingIf a solution is not achieved in the first half of 2025, the expected decrease in the TGA balance will offset the liquidity that would otherwise be drained due to QT and a decrease in Treasury supply.

Thus, the anticipated surge in liquidity from the Treasury should not come as a surprise

Goldman Sachs asserts that the TGA's higher initial levels, alongside any potential repayment volumes, should ideally support a gentler financing environment in the first half of the year relative to conditions absent a debt ceiling, thereby softening the spread of convergence trends that have persisted during the debt limit's restrictions.

Drawing from Goldman Sachs’ insights, an increase in liquidity by an additional $100 billion is comparable to a shift of 0.5 basis points in the SOFR-FF spread, whereas a decline in outstanding bonds amounting to $100 billion results in a 0.1 basis point shiftOverall market pricing has largely factored in these expectations, indicating that most measures narrowing the SOFR-FF spread will likely be deferred to the latter half of the yearHence, markets may be more vulnerable to shocks from a quicker-than-expected resolution of the debt ceiling or a delayed cessation of QT.

Interestingly, over the past year, it has been the constraints stemming from balance sheet capacity that have played a more significant role in inducing fluctuations within the financing markets rather than overall liquidity levels

Although we have now passed the year-end mark, it remains to be seen if these constraints will ease, but it won’t necessarily be attributed to the debt ceiling.

Financial commentary from Zerohedge suggests that, based on the analysis, an improved trajectory in addressing the impending debt ceiling crisis is unattainableThe rapid depletion of the U.STreasury's approximately $750 billion TGA could offer sufficient cushioning for risk assets, likely sustaining their high standings into the latter half of 2025.

Ironically, a resolution to the debt ceiling debacle might paradoxically serve as a headwind for risk assetsThis is rooted in the fact that the Treasury typically moves swiftly to replenish TGA funds post-resolution, which could mean any favorable elements in financing and spread markets might swiftly dissipateGiven that the Federal Reserve's QT strategy appears to be entering a more advanced stage, the Treasury may exercise increased caution in normalizing TGA levels, particularly since its “steady state” target for the TGA is marginally above pre-pandemic levels.

Goldman Sachs notes that the repo market crisis of August to September 2019 might serve as the closest parallel to any unfavorable outcomes

During that timeframe, upon QT's conclusion, the TGA soared just as volatility surged in the financing markets, prompting the Federal Reserve to inject liquidityWhile the outcomes ultimately align, a more gradual approach to bolstering the TGA balance may alleviate the risk of significant volatility tied to rapid liquidity removals from the financial system.

This suggests that as the TGA declines, market liquidity—particularly in stocks and bitcoin—could skyrocketHowever, once a resolution on the debt ceiling materializes, likely in the third quarter of 2025, the Treasury could retract as much as $750 billion from the market, leading to a slump in risk assetsShould pressure from liquidity withdrawal intensify excessively, it might compel the Federal Reserve to reengage in a fresh round of “non-QE”—potentially igniting another inflation spike in the latter part of 2025 and beyond.