Wall Street's Trillion-Dollar Headache Will Arrive When Debt Ceiling Crisis Gets Resolved: Here's How

The debt ceiling crisis is a short-term worry for many investors as a failure to increase or suspend the borrowing limit is expected to cause chaos across financial markets. However, even if a resolution is reached, the barrage of bond sales by the Treasury Department to meet its obligations in the aftermath of a resolution is expected to drain liquidity from the banking system and push up short-term borrowing rates.

The supply is estimated at well over $1 trillion by the end of the third quarter, reported Bloomberg.

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"My bigger concern is that when the debt-limit gets resolved — and I think it will — you are going to have a very, very deep and sudden drain of liquidity," said Ari Bergmann, founder of New York-based Penso Advisors, according to the report. "This is not something that's very obvious, but it's something that's very real. And we've seen before that such a drop in liquidity really does negatively affect risk markets, such as equities and credit."

Once the crisis is resolved, the U.S. cash reserves should soar to $550 billion as of the end of June from the current level of about $95 billion — and reach $600 billion three months later, the report said citing the Treasury Department's most recent estimates.

The impact of such a liquidity drain from the private sector when the economy is already at the cusp of a recession in the wake of persistent rate hikes by the Federal Reserve is something that the market will be watching out for.

RRP: Another aspect that has an impact on liquidity in current times is the central bank's reverse repurchase agreement facility, known as the RRP, using which money-market funds park cash with the central bank overnight.

Matt King at Citigroup Inc. said money funds' tendency to keep cash in RRPs will most likely persist which could mean a sizable drain in bank reserves when the Treasury's cash jumps, the report said.

"We are shifting from a very significant tailwind of global central bank liquidity over the last six months to probably a significant headwind," said King.

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