The US Federal Reserve cut interest rates by 25 basis points last week, but that may not have been the biggest news for bitcoin. bullfighting. The real surprise was the central bank’s announcement to begin buying $40 billion in short-term U.S. Treasury bills.
That sparked a bullish frenzy in the crypto community, and why not? These purchases will expand the Federal Reserve’s balance sheet, much like the 2020 Covid-era quantitative easing (QE) program and post-global financial crisis maneuvers that fueled unprecedented risk-taking in financial markets, including digital assets.
Not so fast, suggests popular pseudonymous observer Conks, known for his deep macroeconomic insights. In a blog post published on Monday, Conks argued that while the latest operation appears similar to QE, it is actually not. This time, the Fed’s action is aimed at ensuring healthy liquidity in money markets, where banks, corporations and investors lend and borrow cash for very short periods, typically overnight to a few months, to manage daily cash needs without locking up money for the long term.
The program is not intended to stimulate the economy or markets, which is where previous QE programs were aimed at.
In short, the central bank is adding liquidity, not stimulus.
For now, the markets seem to agree. Bitcoin rose sharply for a few minutes after the Federal Reserve announcement, but has been declining since then, now down around 7% from $87,000.
“[Latest] “Asset purchases will lack any meaningful easing outside of money markets,” Conks wrote. “Stocks will have to rely on other forces to further scale the wall of worry.”
What is really happening?
The Federal Reserve’s decision to buy short-term bills comes as bank reserves, the cash deposits of commercial banks at the Federal Reserve, recently fell too low. When reserves decrease, the interest rates that banks charge each other overnight increase the money market, causing financial constraints and threatening stability.
The total amount of reserves fell below $3 trillion, the supposedly ample level, in late October, causing those rates to rise sharply.
The purchase of bills by the Federal Reserve will increase cash (reserves) in the banking system, increasing liquidity and reducing the cost of interbank borrowing. This, in turn, guarantees the proper functioning of the money market.
However, this does not actually reduce longer-duration interest rates, which is seen as necessary to stimulate borrowing and investment in the economy and galvanize risk-taking in markets. QE implemented after 2008 and in 2020 involved the Federal Reserve purchasing longer-term Treasury notes and mortgage-backed securities, driving the 10-year yield to unprecedented levels.
Therefore, it is not surprising that the Federal Reserve is calling its latest program RMO (Reserve Management Operations) instead of QE.
Preemptive attack
According to Conks, OMRs appear to be a preventive measure against the possibility of stress emerging in the coming months, especially in April, when the Treasury faces a huge quarterly tax payment deadline.
By mid-April, millions of businesses and individuals are paying estimated taxes to the IRS at the same time, withdrawing hundreds of billions in cash from money market funds and short-term financing systems while they sell assets or deplete deposits.
“As Chairman Powell revealed at the latest FOMC press briefing, officials will imminently implement reserve injections to create a cushion against several incoming ‘blind spots’ arising from a volatile TGA, the big risk centered around April’s infamous tax day,” Conks said. “Following this year’s interbank flows that threaten to induce numerous blind spots, the Fed – now much closer to the system’s lowest comfortable level of reserves (LCLoR) – will take no risks.”
In short, the Federal Reserve does not want to face another event like September 2019, when short-term borrowing rates spiked because reserves fell too low, shaking the system. Therefore, it is anticipating liquidity injections with 40 billion dollars in bill purchases per month.
What does this mean for the markets?
What looks like QE is actually a maintenance operation aimed at ensuring the proper functioning of the financial system. The Fed doesn’t appear to be aiming to raise asset prices or boost growth: it’s making sure the pipes don’t clog as reserves fluctuate.
That said, the Federal Reserve’s action eliminates the risk of a sudden rise in interbank lending interest rates and panic in financial markets. In other words, it has removed a major uncertainty or potential hurdle for risk assets, including bitcoin.
