The United States Federal Reserve (Fed) injected $29.4 billion into the banking system on Friday, generating optimism on crypto social media. While the move was aimed at easing liquidity concerns and supporting risk assets including bitcoin, it is nothing out of the ordinary.
The Federal Reserve pumped billions through overnight repurchase operations, the largest since the 2020 coronavirus pandemic, to ease liquidity stress that has reportedly limited bitcoin’s growth. gains in recent weeks.
The operation, carried out through the permanent repurchase facility (SRF), temporarily increased the cash available at primary dealers and banks and was aimed at adding short-term liquidity to the system, reducing repo rates to normal levels, avoiding a sudden freeze in short-term financing markets and giving banks breathing room to manage reserves while the Federal Reserve monitors the situation.
This all sounds too technical, so let’s break it down to understand how repos, bank reserves, and the latest action from the Federal Reserve are related.
the repository
A repo, or repurchase agreement, is a short-term loan made overnight between two parties: one with cash sitting idle in a bank deposit that wants to generate a return on it, and the other party seeking a cash loan with valuable collateral, such as U.S. Treasury bills and securities.
The two parties agree on an interest rate and the cash is loaned the next day with a promise to repurchase the asset the next day. The lenders in these transactions are typically large money managers, such as money market funds.
bank reserves
Repurchase agreements affect the bank’s reserves. As the lender transfers cash to the borrower, the reserves in the lender’s bank decrease, while those in the borrower’s bank increase. An individual bank is vulnerable to stress if many of its accounts lend money to borrowers at other banks.
Banks need sufficient reserves to meet regulatory requirements and carry out their daily operations, so they themselves can borrow reserves or adjust their balance sheets as necessary. And when they face a shortage, they turn to the repo market or other Federal Reserve facilities, such as the discount window or the Supplementary Financing Rate (SFR).
However, when reserve shortages become severe system-wide, it raises repo rates as loanable cash becomes scarce and more borrowers compete for less cash, causing a liquidity squeeze.
This is where the Federal Reserve comes in, and that is precisely what it did on October 31st. The giant injection of liquidity through the SRF, a tool implemented to provide quick loans secured by Treasury or mortgage bonds, came as bank reserves fell to $2.8 trillion, driving up repo rates.
Loanable cash had become scarce, reportedly due to balance sheet liquidation, known as quantitative tightening (QT), and the Treasury’s decision to increase its checking account at the Federal Reserve, known as the Treasury General Account (TGA). Both withdrew cash from the system.
Putting it all together
- Repo rates increased as loanable cash became scarce due to the Fed’s QT and the Treasury’s cash buildup.
- Bank reserves fell below the assumed breadth threshold.
- The situation caused some stress.
- That led the Federal Reserve to inject liquidity through the SRF mechanism.
How does it affect BTC?
The $29 billion liquidity boost effectively offsets the adjustment by temporarily expanding bank reserves, reducing short-term rates and easing borrowing pressures.
The move helps prevent potential liquidity crises that could harm financial markets, ultimately supporting risk assets like bitcoin, which are considered pure plays of fiat liquidity.
That said, what the Fed did on Friday does not amount to or suggest imminent quantitative easing (QE), which involves direct asset purchases by the Fed, expanding its balance sheet to increase the overall level of liquidity in the system for months or years.
The Federal Reserve’s action on Friday represents a short-term reversible liquidity tool and may not necessarily be as stimulative for risk assets as QE.
Plus, as Andy Constan, CEO and CIO of Damped Spring Advisors, said in X, everything will work out on its own.
“If and only if system-wide reserves suddenly become scarce, more aggressive action by the Fed would be needed. What is happening is a little interbank rebalancing and a little credit stress and a little system tightening for TGA. It will all work out on its own,” Constan said on X.
“If not, rates will have to stay high and increase, and the SRF will have to grow quickly. Before that, it is worth ignoring it,” Constan added.
