'THE FLOODGATES ARE OPEN': The US government is set to begin an unprecedented borrowing binge

flickr / Doug Wertman

• The US government's funding needs are set to increase following the two-year budget agreement that will hike spending.
• And so, the Treasury has boosted the amount of short-term debt it sells. But this is "just the beginning," according to Jefferies.
• A potential risk of higher government spending and the resultant inflation is conflict between the Federal Reserve and the federal government, Jefferies noted.

It's clear that the floodgates are open in front of the US Treasury, Jefferies says.

In January, Treasury raised the amount of long-term debt it sells to help fund the US government for the first time since 2009.

This was done in anticipation of the expected blowout in the deficit, as spending increases faster than revenues. And it was justified in the early hours of Friday, February 8, when the Senate approved a two-year budget deal that would hike spending. The Congressional Budget Office estimates it would add more than $300 billion to the federal deficit over 10 years.

"The recent boost to [Treasury bill] supply is just the beginning," Thomas Simons, a senior money market economist at Jefferies, said in a note Friday.

"Treasury's financing needs are going to explode in FY 2018 and FY 2019 and the initial response is going to be an increase in bill supply, followed by further increases in coupon auction sizes throughout the next 2 years," Simons said.

According to Bloomberg, Treasury will next week hold its largest-ever auctions for three- and six-month bills - $51 billion and $45 billion respectively.

The spending bill injects stimulus into the economy well into a period of recovery - a time when it's not desperately needed. Simultaneously, the Federal Reserve is on track to tighten the leash on the economy and on inflation by raising interest rates at least three times this year.

According to Simons, one risk of this is a showdown in Washington.

"The Fed has been under a persistent attack from Congress for years now, so it is likely that they will faced even more intense heat going forward," he said.

Fed Chairman Jerome Powell will delivery his first testimony on monetary policy in Congress on February 28. Any remarks he makes on inflation and the economy's growth trajectory will be keenly focused on. After all, the stock market is still recovering from its first 10% decline in two years - a correction that was provoked by worries of how the Fed would deal with higher inflation.

Economists like Seth Carpenter, the chief US economist at UBS, expect fiscal stimulus to boost growth and inflation. He raised his full-year forecast for gross domestic product this year by almost 0.2 percentage points, to 2.9%.

But the boost won't be permanent, in his view.

"... we believe the Fed will still need to slow growth further, a delicate balancing act," Carpenter said in a note on Friday.

Beyond how the Fed manages higher growth, the Treasury's response to fiscal stimulus poses its own risks.

"Worse, we see a risk - not our base case - that markets over react to the heavy extra issuance and the long-end sells off, choking the economy," Carpenter said.

"We do not forecast a recession as our base case, but we believe the risk is material and rising."