All our times have come
Here, but now they're gone
--Blue Oyster Cult
Stress continues to build in the short term Treasury market. T-bill yields are ripping higher (read: supply) as are prices of 1 yr Treasury credit default swaps (read: demand). Why the extra stress on the short end of the curve? Because markets are figuring that any technical default on Treasury debt (currently estimated at 6.5% by 1 yr CDS) will have an outsized effect on near-term borrowing.
Few groups are likely more nervous right now than the big banks. Banks have been exchanging collateralized securities for short term loans to fund huge speculative trading operations. These trades, known as repurchase agreements or 'repos,' enable banks to lever up big time (30:1 or more) while, because of their short term nature, steering clear of regulators.
US Treasuries, particularly shorter dated ones, provide the bulk of collateral that banks use to obtain their repo funding. If the price of US debt continues to fall, then the value of bank collateral falls as well, which could render highly levered banks severely under capitalized or insolvent.
The repo market would grind to a halt as would interbank lending. At least $600 billion in liquidity would likely drain from the banking system.
Stated differently, the big banks have been exploiting the 'full faith and credit' feature of US securities, that to this point has come out of the hides of US citizens in the form of taxes and crushing debt, to take on extraordinary risk in pursuit of $billions. They are praying that Capitol Hill will once again cave to pressure that keeps their nefarious, monster sized, repo-funded carry trade alive.
Plus, if things go bad, the big banks figure the Fed will step in and bail them out as always.
This set-up is similar to 2008, which demonstrates once more how little has structurally changed over the past five years.