Dollar-denominated funding markets are already facing myriad challenges that are distorting supply and demand, and these effects are only going to intensify as a return of the U.S. government's statutory borrowing limit gets closer.

Rates for short-term dollar borrowing have been driven to zero and below, weighed down by Federal Reserve asset purchases, a drawdown of the U.S. Treasury's mammoth cash pile, and a shift from bank deposits to money-market funds. The re-imposition of the debt ceiling at the end of July, after its suspension in 2019, is threatening to exacerbate this dynamic, as its return also affects how much spare cash the Treasury can legally hold.

The reinstatement will force the Treasury to wind down its cash balance to levels near the previous suspension, or roughly $120 billion to $130 billion, from $924 billion now. That would push more cash into the market, while simultaneously yanking supply out of the market with bill paydowns.