Over the past year, the sales of US Treasury bonds have continued to rise, sparking a debate on Wall Street about whether there will be enough demand to avoid disrupting the financing market.

Since the beginning of 2023, the Treasury has issued $2.23 trillion in short-term bonds and recently increased supply to compensate for the government's deficit. The interest paid on the balance of US debt continues to push up the federal government's budget deficit, which has grown to $1.27 trillion for the fiscal year ending in June.

So far, the market seems to have calmly accepted this situation, as can be seen from the pricing of short-term bonds and other risk-free rate products (such as overnight index swaps), the latter of which has remained relatively stable. However, people are concerned that the Fed's eventual arrival of interest rate cuts and quantitative tightening (i.e. QT) will lead to tensions in the funding market. Some fear that this pressure may even be similar to the turmoil that forced the Fed to intervene four years ago.

Torsten Slok, chief economist at Apollo Global Management, believes that once the Fed starts cutting interest rates (possibly in September), the appetite for household and money market funds may decrease, thereby putting upward pressure on short-term bond rates.

Slok wrote in a report last week: 'As the Fed conducts QT, the amount of outstanding debt continues to increase, which increases the risk of unexpected events in the funding market, a situation similar to what we saw in September 2019 in the repo market.'

Others on Wall Street disagree. As investors flooded into the money market after the Fed raised rates to their highest level in decades, total money market assets reached $6.14 trillion, nearly matching the record high set last week. They say that this cash will remain abundant for higher returns.

Mike Bird, senior portfolio manager at Allspring Global Investments, said: 'Claims that demand for Treasuries will weaken during a Fed easing cycle are overstated. We will maintain our appetite for money funds, especially for these. This demand will not disappear.'

As the Fed gets closer to cutting interest rates, money market funds are lengthening asset maturities—buying more longer-term government bonds to lock in higher yields after rate cuts begin. This means that companies that have been buying short-term bonds directly will shift cash to funds to take advantage of lagging yields, which will increase the money market's appetite.

Teresa Ho, head of US short rates at JPMorgan, said: 'In the three easing cycles prior, funds did not outflow from money market funds until the Fed moved far into their easing cycle, so funds continue to flow in. At least 4% to 5% of yield is still very high. '

Since the Fed's first rate hike in March 2022, about $1.33 trillion has flowed into US money market funds, more than half of which came from individual investors. Deborah Cunningham, Chief Investment Officer of Federated Hermes Global Liquidity Markets, said that these assets could have reached $7 trillion in the past, especially since much of the cash from institutional investors such as corporations has yet to move.

In addition, money market funds are already the largest buyers of short-term bonds, but facing new requirements from the SEC, may become even larger buyers. These measures, effective in October, will require some funds to impose liquidity fees during times of financial stress, which will raise the cost of fund redemption. This will come at the expense of higher-risk assets, boosting demand for Treasury securities and other financial instruments.

As for supply, the market may face a decline in issuance as the debt ceiling is reinstated on January 1. Once this happens, government departments will take steps to stay under the ceiling before exhausting their borrowing power, including significantly reducing sales of short-term bonds. This may create an imbalance on the frontend, similar to the period from 2021 to 2023 when there were more cash assets than investable assets available.

Meanwhile, the Treasury will continue to issue short-term bonds to provide funding for larger deficits. Mike Bird of Allspring said: 'The Treasury won't just issue bonds willy-nilly. This is where they can get the most money when they need it—by ensuring there is demand for the product. '

Moreover, money market funds are already the largest buyers of short-term bonds, but they may become even larger buyers facing new requirements from the SEC. Effective in October, some funds will be required to impose liquidity fees during times of financial stress, which will raise the cost of fund redemption. This will come at the expense of higher-risk assets, boosting demand for Treasury securities and other financial instruments.

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