For much of 2022, the cryptocurrency market focused on the actions of the US Federal Reserve. Central banks have created a bearish environment for risk assets such as stocks and cryptocurrencies by raising interest rates on borrowing.
Towards the end of 2022, positive economic data, healthy job numbers and subdued inflation offered hopes of a long-awaited slowdown in rate hikes. The market now expects rate hikes to decline from 50 basis points (bps) to 25 bps before the rate hike regime comes to a complete end by mid-2023.
In terms of the Fed’s goal to curb liquidity and headwind the overheated economy and stock markets, things are starting to improve. His plan for a soft landing with quantitative tightening to keep inflation in check without sending the economy into deep recession seems to be working. The recent rally in the stock market and Bitcoin can be attributed to the market’s faith in the above narrative.
But another important US institution, the US Treasury, poses significant risks to the global economy. While the Federal Reserve drained liquidity from the market, the Treasury provided a countermeasure by draining its cash balances and nullifying some of the Federal Reserve’s efforts. This situation may be coming to an end.
It poses the risk of constrained liquidity conditions with the potential for economic shocks. Analysts have therefore warned that we could see excessive volatility in the second half of 2023.
Backdoor Liquidity Injection Denies Fed Quantitative Tightening
The Fed started quantitative tightening in April by raising interest rates on borrowed money. Its purpose was to curb inflation by limiting market liquidity. His balance sheet shrunk by $476 billion during this period. This is a positive sign given that inflation remains low and employment levels remain healthy.
At the same time, however, the US Treasury has used the US Treasury General Account (TGA) to inject liquidity into the market. Treasuries typically sell bonds to raise additional cash to meet their obligations. But as the country’s debt approached the debt ceiling level, the federal government used that cash to cover the deficit.
In effect, this is a backdoor liquidity injection. TGA is the net debt on the Fed’s balance sheet. The Treasury Department has drained him $542 million from his TGA account since April 2022, when the Fed began raising rates.Independent Macro Market Analyst Lynn Alden He told Cointelegraph:
“The U.S. Treasury is reducing cash balances to keep from exceeding the debt ceiling adding liquidity to the system. So the Treasury is offsetting some of the QT that the Fed is doing. Once the debt ceiling issue is resolved, the Treasury will replenish cash accounts and draw liquidity out of the system.”
Debt ceiling issues and potential economic implications
The US Treasury’s debt reached approximately $31.45 trillion as of January 23rd. This figure represents the total amount owed by the U.S. government accumulated over the course of U.S. history. This is very important because the Treasury debt ceiling has been reached.
The debt ceiling is an arbitrary number set by the US government that limits the amount of US Treasuries that can be sold to the Federal Reserve. Hitting it means the government can no longer assume additional debt.
Today, the United States must pay interest on $31.4 trillion in national debt and spend it on national welfare and development. These expenditures include salaries for public health workers, educational institutions, and pensioners.
Needless to say, the US government spends more than it earns. So if we can’t increase our debt, we’ll have to cut either interest payments or government spending. The first scenario implies a US Treasury default. This starts with a loss of confidence in the world’s largest economy, opening a big can of worms. The second scenario poses uncertain but real risks. Failure to pay for public goods can lead to political instability in the country.
However, no limit has been set. The U.S. Congress has voted on and changed the debt ceiling many times.U.S. Treasury Department Note “Since 1960, Congress has taken action 78 times to permanently raise, temporarily extend, or modify the definition of the debt ceiling. 29 times.”
If history shows, Congress is more likely to solve these problems by raising the debt ceiling before any real damage is done. However, in that case the Treasury will tend to increase his TGA balance again. The division’s goal is $700 billion by the end of 2023.
By June the liquidity backdoor injection into the economy will end, either by drying up liquidity entirely or with the help of debt ceiling revisions. It can create a difficult situation for risk-on assets.
Correlation Between Bitcoin and Stock Markets Remains Strong
The correlation between Bitcoin and US stock market indices, especially the Nasdaq 100, remains close to all-time highs. Alden pointed out that the FTX collapse dampened the cryptocurrency market in his fourth quarter of 2022, with stocks rebounding on expectations of a slowdown in rate hikes. Congress is delaying a decision on the debt ceiling, but good liquidity conditions are boosting the price of bitcoin.
However, the correlation with the stock market remains strong, and movements of the S&P 500 and Nasdaq 100 may continue to affect Bitcoin’s price. Financial researcher Nick Batia I have written On the importance of Bitcoin’s stock market direction. He said,
“…In the short term, market prices can be very wrong. But in the more medium term, trends and trend reversals must be taken seriously.”
Markets are expected to remain vulnerable through the second half of 2023 due to risks from ongoing Fed quantitative tightening and the suspension of Treasury liquidity injections.
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