The US Treasury’s Cash Management Could Undermine Fed Independence

The Treasury Government Account (TGA), which is the US Treasury’s checking account at the Fed, has become so large that the Fed may have to coordinate with the Treasury to adjust its stance, which market participants could view as inconsistent with Fed independence.

The COVID-19 Budget Relief Has Not Been Fully Spent

The TGA build-up since March reflects slower-than-expected spending of COVID-19 relief (Table 1). In response to the pandemic, Congress voted for four relief bills during March-April that increased public expenditure by about $2.6tn and which were reflected in the higher 4 May quarterly refunding issuance forecast. However, April-June government funding needs turned out to be $1.1tn below the Treasury. With the Treasury issuing $0.2tn less than expected, the end-June TGA, or money left in the Treasury’s account at the Fed, turned out to be $0.9tn above expectations.

In the 3 August refunding statement, the Treasury raised its estimate of July-September government funding needs by $1.1tn, based on expectations of a $1tn additional COVID-19 relief bill as well as of a catch up on spending of the previous bills. At the same time, the Treasury plans to underfund the government by about $0.9tn to bring the TGA close to its $0.8tn end-quarter target.

Lowering the TGA Could Prove Difficult

Lowering the TGA to $0.8tn by end-September could be difficult for two reasons. First, there is a risk that a further COVID-19 bill may not get passed, either because of lack of bipartisan compromise or because the economy recovers faster than expected. Recent news on vaccines, treatment, and new cases suggests economic normalization could be much closer than currently assumed by policymakers. In that regard, unemployment claims over the next few weeks will be key indicators.

Second, spending of the funds appropriated under the first coronavirus bills could be more difficult than expected. To expedite spending, the Office of Management and Budget (OMB) allowed government agencies to wait until July to report bill-related financial commitments and spending. An early comprehensive estimate has only recently become available but in some instances is inconsistent with other sources of information on government spending.

Nevertheless, even with the limited data available, it is clear that the reasons for underspending the bills will not be addressed easily. The four COVID-19 bills have appropriated $2.6tn, mostly between four agencies: the Treasury, Small Business Administration (SBA), Department of Labor (DoL), and the Department of Health and Social Services (HHS). And of the $2.6tn, only about $1.4tn has been spent (Table 2). Most of the shortfall in spending has come from the Treasury and the SBA and is unlikely to get resolved over the reminder of CY2020. By contrast, the HHS and DoL seem likely to spend their appropriations fully.

The Treasury Reaction Function

While spending of the COVID-19 appropriation is likely to remain below $2tn this year, the Treasury reaction to underspending could add upside to the TGA. In the Refunding Statement, the Treasury has stressed that the actual decline in the TGA ‘will depend on several uncertain factors, including the pace of outflows under current law and the potential for additional legislation. Informed by its risk management objectives, the Treasury has taken a precautionary approach to projecting outflows. Accordingly, the Treasury’s cash balance may remain elevated by historical standards until the uncertainty regarding potential outflows diminishes.’

This suggests that the Treasury will take a conservative approach to underfunding the government in Q3 and will wait for clear evidence that a compromise on a further COVID-19 bill will not be reached before adjusting down its issuance. This suggests limited downside and possibly some upside to the TGA this quarter as issuance adjustment would likely not come until the end of the quarter.

Large TGA Could Be Inconsistent with Fed Independence

Most of the expansion in the TGA is behind us and has not prevented a swift recovery in equity markets, which could reflect that reserves have increased by an extraordinary amount, by $1.6tn during March-May 2020. After the 2008 market collapse, by contrast, it took 2.5 years for the Fed to grow its reserves by the same amount.

Going forward, the very large TGA could limit the Fed’s ability to adjust its policy. For instance, the Fed has allowed reserves to fall, possibly in expectation of a TGA unwind. If the unwind does not come, reserves could fall by more than is consistent with the Fed floor operational framework. This is not an issue for now because of the recent very large increase in reserves, but it could become so in future.

The Fed has tended to run its floor operating framework with fewer reserves than is consistent with stable money market rates. This has led to market volatility in Q3 2019 that could happen again. In any event, the TGA is now so large that the Fed may have to coordinate policy changes with the Treasury, which market participants could perceive as inconsistent with Fed independence.