Is BTC$ Leading Markets Down? And Will The Fed Re-Start QE?

The Fed ‘Put’ Returns… But Only For Repo!

The price action of the most liquidity-sensitive asset on the planet is looking bad: Bitcoin has plunged down through its 200-day moving average, without blinking. This seems a tad bigger volatility than historically, and pretty much scotches the ‘4-year’ cycle narrative. Evidence the chart below. Media pundits are gloating; many others are scratching their heads, but the underlying reason is that Global Liquidity conditions have deteriorated. So, where are we headed? Is Wall Street also under threat?

Our chart of weekly changes in Global Liquidity and Bitcoin has been warning for some time of likely weakness ahead. [6-week changes are designed to emphasise the ‘signal’ over ‘noise’]. The change in Global Liquidity has been advanced by 13-weeks to show how it leads BTC$, among other assets.

Higher frequency data confirm this on-going slide in liquidity. The next chart shows the daily nowcast of our broad GLI (Global Liquidity Index), a measure of the underlying momentum of Global Liquidity. This peaked on August 1^st and has skidded ever since. Alongside we have plotted a companion index of market liquidity as a cross-check. This calibrates price spreads and measures of volume depth, largely across bond and forex markets. It appears to back-up the observed fall in funding liquidity.

US Fed and China’s PBoC Cut Back Liquidity

Drilling into the underlying data to find reasons: there is a clear explanation for the deterioration, evidenced in the text box (above) that summarizes our upcoming Weekly Liquidity Report. The key messages is that, first, PBoC (People’s Bank) Liquidity injections into China’s money markets has wobbled. It is still up year-over-year, but the pace has plainly slowed as the following chart evidences. This may be because Chinese policy makers are defending the Yuan against the firming US dollar.

Second, and potentially part of the reason the dollar has firmed, US Fed Liquidity has dropped in absolute terms. [Fed Liquidity is a concept we define from the liquidity-creating parts of the Fed balance sheet. It is frequently the case that the two move differently.] We have featured ours concerns over recent weeks about how this liquidity drop would negatively impact US repo markets. The underlying cause is the forced refill of the TGA (Treasury General Account) following the lifting of the Federal debt ceiling and, more recently, by the temporary effect of the government shutdown. From a peak on June 12^th to the low on October 30^th, together these two factors took a whopping US$550 billion out of US money markets.

Admittedly, some cash stimulus is currently dribbling back into money markets, now the government has reopened, but even adding to this the impact of the recently announced ‘End of QT’, US banks’ reserves are slated to remain sub-par into 2026. This is evidenced by repo market spreads, here shown against IORB, the interest rate set by the Fed on overnight reserve balances.

Damage to Repo

So far this divergence is an inconvenience for the Fed. The worry is, like 2019, that it could lead to a bigger problem if left to fester. The fundamental cause remains the large Federal deficit and the desire by Treasury to fund this gap through bills and short-dated debt, which more-or-less compels them to operate with a ‘large’ TGA balance. The TGA balance typically covers around 5-days of future spending, which includes the need to roll US$500 billion of bills and US$125 billion of notes each week, following the recent step-up in short-term debt issuance, plus up to US$125-150 billion of interest payments and net fiscal spending. Adding up these commitments, gives a minimum cash holding of near-US$800 billion, suggesting that the Treasury has little scope to slash the TGA as dramatically as some have suggested.

Caught between the Devil and the deep blue sea, a bigger TGA drains liquidity, but then so does greater coupon issuance, such as selling more 10-year Treasury notes. The subtle hope when funding the deficit through bills is that banks tend to buy these securities by expanding their balance sheets, rather than by using existing private savings. This is monetization, pure and simple.

In other words, if the TGA can be kept low enough and the banks encouraged to buy more Treasury debt, then broader US liquidity conditions could expand. The current problem is that although the banks are buying, they are not buying enough, leaving the hefty bill issuance to fall largely on the shoulders of money market funds and other sources of repo liquidity. This drain of cash reduces money market liquidity, and, hence, banks’ reserves. In turn, this illiquidity forces repo rates above Fed targets. Consider the close movement in the chart below between the (inverted) spread of SOFR (repo rates) less the Fed’s targeted IORB (interest on reserve balances), and banks’ excess reserves. Here correlation does mean causation!

Looking Ahead: A Repo ‘Put’?

Given that the market is hunting for good news, it might take some solace from the rumoured likely re-start of QE, or strictly ‘Not QE, QE’. We use this latter description, because the Fed is pains to stress that this will not be a ‘true QE’ (whatever that means?), rather a technical move to remove repo market stress. In contrast, our view is that liquidity is simply liquidity, and more is almost certainly coming.

However, the key question is how much more? We suspect the answer is ‘not enough’. Sure, restarting QE to the likely tune of US$250 billion annually will ease the current pain a tad, but on our calculations US banks’ reserves will remain sub-par into next year and repo market tensions will persist, unless a full-scale QE, not a half-hearted QE, is undertaken.

The future (and current) threat to risk assets is plain from the following chart. This tracks Fed Liquidity (red line) against subsequent movements in the S&P500 index (orange line). Both are shown in levels, and the S&P5000 has been lagged by 26 weeks (i.e. 6 months) to show its movements often follow liquidity. [Note BTC$ moves earlier as the earlier chart flags.] The broken red line is our projection of Fed Liquidity to end-2026. It includes seasonal effects and assumes: (1) QT ends on Dec 1^st; (2) a US$20 billion monthly QE begins from January; the (3) TGA remains targeted at US$850 billion, and (4) US$120-130 billion of liquidity is absorbed through ‘normal’ cash demands for monetary circulation.

A ‘Repo Put’ …But That’s All?

Something bigger is needed, but what potentially prevents this is the three-way split on the FOMC and wider Fed board between:

• Monetary ‘plumbers’, e.g. Lorrie Logan (Dallas Fed President and former SOMA Manager at NY Fed);

• ‘Trump-ites’, e.g. Governors Stephen Miran and Christopher Waller, and

• ‘Orthodox’ Central Bankers, e.g. Jay Powell (Fed Chair) and John Williams (NY Fed President)

The scale of these divisions suggest that camp #1 will always be out-voted by #2 and #3, who both see no merit (arguably de-merit) in any move to boost the size of the Fed balance sheet.

In short, the Fed has painted itself into a corner with a ideological barrier to a renewed ‘true’ QE, at a crucial time when the Treasury is pursuing a policy of ‘spend-and-fund short-term’, which threatens to drain money markets of liquidity. It is a policy shift we have previously described in terms of a move from ‘Fed QE’ to ‘Treasury QE’. It benefits Main Street, but likely hurts Wall Street. And, this policy is neatly expressed through FOMC member Stephen Miran’s paradoxically demands for lower Fed interest rates and a smaller Fed balance sheet.

The repo markets are currently venting these tensions. The Fed is likely to try to plug the repo liquidity gap with an extra few hundred billion of liquidity, when in reality two or three times as much is needed. Until they come around, risk markets will remain nervous and volatile. Be warned: the sell-off BTC$ may be a warning for other risk assets.