The debt ceiling impasse is adding another layer of volatility to an already unstable funding situation at U.S. banks, and there are no signs that it will ease up in the near future.
Over the next week or so, the deadlock threatens to upend financial markets and incite widespread chaos if a deal isn't reached before the U.S. Treasury runs out of cash, which administration officials estimate could happen around June 1.
But even assuming the White House reaches an agreement with House Republicans, uncertainty around deposit levels is expected to persist. Some deposits may flow into banks as part of a flight to safety, but when the fog clears, the cash could leave as quickly as it arrived.
Because the stickiness of certain deposits is unknown, banks that receive debt ceiling-related deposits should think about those inflows as "short-term unless proven otherwise," said Tod Gordon, a senior advisor at the advisory and investment firm Klaros Group.
"If money is moving in one direction, it could easily move in the other direction," Gordon said.
It's too early to tell if investors are yanking cash out of money market funds that invest in U.S. government securities and parking it in bank accounts as a result of the debt ceiling standoff. Federal data on deposit flows usually lags by about two weeks.
In general, deposits at banks have been
As of May 10, end-of-period deposits were down $58 billion from the previous week to $15.9 trillion, federal data shows. As of May 17, government money market funds were up $9.6 billion week over week, according to the Investment Company Institute.
Money market funds that invest in government securities have seen major inflows as interest rates have risen over the last year. But the debt ceiling standoff could cause some investors to think twice about parking their money in instruments backed by the U.S. government.
Asset growth in government money market funds has "certainly slowed quite a bit" in recent weeks, according to David Smith, an analyst at Autonomous Research.
One outcome of the debt ceiling impasse could be "some relief for bank deposits … at least temporarily if there's a technical default or major intervention from the government that spurs a flight away from [Treasury] bills or the [money market funds] that hold them," Smith wrote in a research note.
From a near-term funding perspective, that could be a plus for banks, Smith said in an interview. But the broader impact on the economy would likely be a huge negative.
"Banks want more deposits, but not like this," Smith said.
Christopher Wolfe, an analyst at Fitch Ratings, said it wouldn't surprise him to see some money shifting away from government money market funds until the debt ceiling impasse is resolved. Any inflows at banks, however, are likely to be temporary because the banks are paying relatively low yields on deposits, he said.
"Once it blows over, that money will probably go back to where it came from," Wolfe said.
Banks also face significant uncertainty over the fallout from any resolution of the debt ceiling deadlock. The volatility centers around the U.S. Treasury needing to refill what is essentially its checking account. That account has been dwindling in recent weeks as the Treasury pulls from its piggy bank to pay for government expenses.
As of last week, the Treasury's account stood at just $68 billion. TD Securities expects the government will want to rebuild that balance to about $650 billion over several months. The Treasury will accomplish that by borrowing money — much of it by issuing short-term Treasury bills that investors will buy.
"The problem is they're going to be doing so so quickly that it's difficult to say exactly where the money will come from to buy those bills," said Gennadiy Goldberg, senior U.S. rates strategist at TD Securities.
If bank depositors are making the purchases, that could spell trouble for the industry. Depositors would pull money from their bank accounts to buy Treasury bills, leading to deposit outflows.
The other option is that money market funds will soak up the increased supply of Treasury bills. Those funds invest in short-term securities, including Treasury bills, to offer their investors a safe place to park cash and earn some yield.
But money market funds can also stick their cash at the Federal Reserve, and daily usage of the facility where they do so has risen to more than $2 trillion. Those money market funds compete with bank deposits, and the sheer size of the Fed's facility has come under focus as competition for deposits becomes more intense.
With interest rates rising over the past year, moving cash to the Fed has been a good strategy for money market funds, giving them a safe yield that bumps up with every Fed rate hike.
If Treasury bills start looking more attractive — say, because markets expect the Fed to stop its rate hikes — then money market funds will likely put more of their cash into the new T-bills the Treasury issues.
That would be a positive outcome for banks, Goldberg said.
But if the demand for new Treasury bills instead comes from bank customers, deposits will decline and banks' reserves will dip. That would come at a time when Fed's policies are having the effect of gradually reducing both deposits and banks' reserves. The central bank is pulling $95 billion a month from the financial system, a reversal of its pandemic-era bond purchase spree.
The last time that the Fed embarked on a similar program of "quantitative tightening," it was forced to abruptly reverse course in September 2019 following large disruptions in short-term money markets.
The disruptions in 2019 reflected shortages in some banks' available reserves, a scenario the Fed will have to keep in mind if the Treasury's efforts to replenish its coffers prompt outflows from banks.
But as long as things stay relatively stable, the Fed will want to keep its quantitative tightening on autopilot, said David Fanger, senior vice president at the ratings firm Moody's Investors Service.
The bank failures in March clearly weren't seen as a big enough shock for the Fed to stop its balance sheet unwind, Fanger said. "So I think it would have to be a pretty systemic event," he added.
