Original title: Sasa
Original author: Arthur Hayes
Original source: https://substack.com/
Translated by: Daisy, Mars Finance
Hokkaido is experiencing unprecedented heavy snowfall, with powder snow accumulating astonishingly thick. Thus, the backcountry access opened in late December, instead of the usual first or second week of January. With the arrival of 2025, the question in the minds of cryptocurrency investors is whether the 'Trump effect' will continue. In my latest article (The Truth about Trump), I suggested that the high expectations for the Trump camp's policy actions might disappoint the market. I still believe this could be a negative factor that puts pressure on the short-term market, but at the same time, it must balance the impact of dollar liquidity. Currently, Bitcoin's movements fluctuate with changes in dollar supply. The financial decision-makers at the U.S. Federal Reserve and the Treasury determine the amount of dollar supply in global financial markets.
Bitcoin bottomed out in the third quarter of 2022 when the Federal Reserve's reverse repurchase mechanism (RRP) peaked. Under the influence of U.S. Treasury Secretary Yellen (whom I jokingly call 'bad girl Yellen'), the U.S. Treasury reduced the issuance of long-term bonds while increasing the issuance of short-term zero-coupon bills, draining over $2 trillion from the RRP. This injected liquidity into the global financial markets. Cryptocurrencies and stocks (especially large tech stocks listed in the U.S.) surged as a result. The chart above shows the relationship between Bitcoin (left axis, yellow) and RRP (right axis, white, inverted); as you can see, Bitcoin prices rise as RRP declines.
The question I am trying to answer is whether, at least in the first quarter of 2025, the positive dollar liquidity shock can overshadow the negative impact caused by the disappointing speed and effectiveness of Trump’s so-called crypto-friendly and business-friendly policies. If so, market risk appetite could continue to rise, and Maelstrom (the assumed investment fund or institution) should increase its risk exposure.
First, I will discuss the Federal Reserve, which is a secondary consideration in my analysis. Next, I will explore how the U.S. Treasury responds to the debt ceiling issue. If politicians hesitate over the debt ceiling, the Treasury will inject liquidity by depleting its funds in the Federal Reserve's general account (TGA), creating positive momentum for the cryptocurrency market.
Federal Reserve
The Federal Reserve's quantitative tightening (QT) policy is continuing at a pace of $60 billion per month, meaning its balance sheet is shrinking. The Fed's forward guidance on the pace of QT has not changed. I will explain the reasons later in the article, but my prediction is that the market will peak between mid to late March, meaning that QT will remove about $180 billion of liquidity from the market from January to March.
The balance of the RRP (reverse repurchase mechanism) is approaching zero. To fully deplete the funds in this mechanism, the Federal Reserve recently adjusted the RRP policy rate. At the meeting on December 18, 2024, the Fed lowered the RRP rate by 0.30%, which was more than the 0.05% drop in the policy rate. This adjustment aims to tie the RRP rate to the lower limit of the federal funds rate (FFR), thus reducing the attractiveness of holding funds in that mechanism.
If you want to understand why the Federal Reserve only aligns rates with the FFR lower limit when RRP is nearly depleted, I recommend reading Zoltan Pozar's article (Cheating on Cinderella). My conclusion is that the Federal Reserve is exhausting all available tools to enhance demand for U.S. Treasury issuance before it may stop QT, provide supplementary leverage exemptions to U.S. commercial bank branches, or even resume quantitative easing (QE), commonly known as the 'money-printing machine mode.'
Currently, there are two pools of funds that can help suppress the rise in bond yields. For the Federal Reserve, the 10-year U.S. Treasury yield must not exceed 5%, as this level would trigger high volatility in the bond market (MOVE index). As long as RRP and TGA (Treasury General Account) have liquidity, the Federal Reserve does not need to significantly change its monetary policy, nor does it need to acknowledge that fiscal dominance is occurring. Fiscal dominance means Powell will become the 'bad girl Yellen' and Scott Bessent after January 20, 2025, will be his 'weak vassal.' I haven't thought of a suitable nickname for Scott yet. If he can make the dollar devalue against gold, making me a modern 'Scrooge McDuck,' I would flatter him a bit when choosing a nickname.
Once the TGA (Treasury General Account) is depleted (bringing positive dollar liquidity) and subsequently replenished due to the touching and raising of the debt ceiling (bringing negative dollar liquidity), the Federal Reserve will lose its means to curb the continuously rising yields through ad hoc measures. This situation has emerged since the beginning of the rate-cutting cycle in September last year. However, this has little impact on the dollar liquidity situation in the first quarter, it is just an idea regarding how the Fed's policy might evolve later this year if yields continue to rise.
By comparing the upper limit of the FFR (Federal Funds Rate) (right axis, white, inverted) with the 10-year U.S. Treasury yield (left axis, yellow), it is clear that while the Fed is cutting rates in the face of inflation above the 2% target, bond yields are rising.
The real question lies in the speed at which the RRP (reverse repurchase mechanism) declines from about $237 billion to zero. I expect this process to complete in the first quarter as money market funds (MMFs) withdraw and purchase higher-yielding short-term Treasury bills (T-bills) to maximize returns. It should be noted that this will inject $237 billion of dollar liquidity in the first quarter.
After adjusting the RRP rate on December 18, short-term Treasury yields with maturities of less than 12 months have exceeded 4.25% (white), which is also the lower limit of the FFR.
The Federal Reserve will remove $180 billion of liquidity through quantitative tightening (QT), while injecting an additional $237 billion of liquidity due to the reduction in RRP balances resulting from the adjustment in RRP reward rates. The net result is a total increase in liquidity of $57 billion for the first quarter.
Treasury Department
'Bad girl' Yellen has indicated to the market that she expects the Treasury to begin taking 'extraordinary measures' to finance the U.S. government between January 14 and 23. The Treasury has two ways to pay government bills: one is to issue debt (which brings negative dollar liquidity), and the other is to use funds from its check account at the Federal Reserve (TGA, which brings positive dollar liquidity). Since the total debt cannot increase until Congress raises the debt ceiling, the Treasury can only use the funds in its TGA account. Currently, the TGA balance stands at $722 billion.
The first important assumption is when politicians will agree to raise the debt ceiling. This will be the first test of Trump's support among Republican lawmakers. Remember that his governing majority advantage—i.e., the Republican seat advantage in the House and Senate relative to the Democrats—is very slim. There is a faction within the Republican Party that talks a big game about the importance of reducing the size of government during every discussion about the debt ceiling and insists on not raising the debt ceiling unless their constituencies can benefit. Trump previously failed to convince these lawmakers to block the spending bill through the end of 2024 unless the debt ceiling was raised. Meanwhile, the Democrats, having suffered a disastrous defeat in the last election over 'gender-neutral bathrooms,' have no interest in helping Trump unlock government funds to achieve his policy goals. As for the Democratic presidential candidate in 2028, will it be Harris? Actually, it’s more likely to be that 'silver fox' Gavin Newsom.
Therefore, to advance matters, Trump would be wise to keep the debt ceiling issue off the table in any proposed legislation until absolutely necessary.
The point in time when raising the debt ceiling becomes necessary is when failing to do so would result in a technical default (i.e., being unable to pay maturing Treasury bonds) or a total government shutdown. Based on the revenue and expenditure data released by the Treasury for 2024, I estimate this could happen between May and June of this year, at which point the TGA balance will be completely depleted.
To intuitively understand the pace and intensity of TGA (Treasury General Account) funding for the government and to predict its maximum impact when it is depleted can help us understand market trends. The market is forward-looking. Given that this data is all public and we know how the Treasury operates when the total U.S. debt cannot increase and the account is nearing depletion, the market will look for new sources of dollar liquidity. When TGA is 76% depleted, March seems to be the time when the market will ask 'what's next?'
If we add the total amount of dollar liquidity from the Federal Reserve and the Treasury before the end of the first quarter, the total is $612 billion.
What happens next?
Once default and government shutdown loom, both sides will reach a last-minute agreement to raise the debt ceiling. At that point, the Treasury will be able to net borrow again and must refill the TGA account. This will have a negative impact on dollar liquidity.
Another important date in the second quarter is April 15, the tax payment deadline. As can be seen from the table above, the government's fiscal situation improves significantly in April, which negatively impacts dollar liquidity.
If changes in the TGA balance are the only factor determining cryptocurrency prices, then I expect the market to reach a local peak by the end of the first quarter. In 2024, Bitcoin reached a local peak of about $73,000 in mid-March, then consolidated and began a months-long decline on April 11 (just days before the tax deadline).
Trading Strategy
The issue with this analysis is that it assumes dollar liquidity is the most critical marginal driver of global fiat currency liquidity. However, other factors also need to be considered:
Will China accelerate or slow down the pace of RMB credit creation?
Will the Bank of Japan begin to raise policy interest rates, thereby pushing up the dollar-yen exchange rate and unwinding leveraged arbitrage trades?
Will Trump and Bessent conduct a massive overnight devaluation of the dollar against gold or other major fiat currencies?
How efficient is the Trump team in rapidly cutting government spending and passing legislation?
These major macroeconomic issues cannot be known in advance. However, I am confident in the mathematical model of the RRP (reverse repurchase mechanism) and TGA (Treasury General Account) balance over time. This confidence is further supported by the fact that since September 2022, the increase in dollar liquidity resulting from the decline in RRP has directly driven the rise of cryptocurrencies and stocks, despite the Federal Reserve and other central banks raising interest rates at the fastest pace since the 1980s.
FFR upper limit (right axis, green) vs Bitcoin (right axis, magenta) vs S&P 500 index (right axis, yellow) vs RRP (left axis, white, inverted)
Bitcoin and stocks bottomed out in September 2022, beginning to rise as over $2 trillion of dollar liquidity was injected into global markets following the decline in RRP. This was a deliberate policy choice by 'bad girl' Yellen to drain RRP by issuing more short-term Treasury bills (T-bills). This completely offset Powell's efforts to tighten financial conditions to combat inflation.
After considering all the constraints, I believe I have answered the initial question I posed: The potentially disappointing 'bamboo shoots' (risks) of the Trump team regarding their support for cryptocurrency and legislation for business may be masked by an extremely positive environment of dollar liquidity—up to $612 billion in liquidity growth in the first quarter. As planned, just like almost every year, it's time to 'sell and rest' in the later stages of the first quarter. Whether on the beach, in nightclubs, or at ski resorts in the Southern Hemisphere, we can wait for the positive fiat currency liquidity conditions to reappear in the third quarter.
As the Chief Investment Officer of the Maelstrom Fund, I would encourage the fund's risk-takers to dial the risk dial to DEGEN (extreme speculation). The first step towards this direction is to decide to venture into the emerging decentralized science (DeSci) space. We love undervalued 'shitcoins,' so we bought $BIO, $VITA, $ATH, $GROW, $PSY, $CRYO, and $NEURON. If you want to understand why Maelstrom believes the DeSci narrative has significant revaluation potential, please read (Degen DeSci). If the overall development goes as I described, I will 'switch benchmarks' in March and swing to the high sound of 909's open.
Of course, anything can happen, but considering the whole picture, I still remain bullish. So, have I changed my perspective from the previous article? You could say yes. Perhaps the 'Trump sell-off' won't happen in mid-January 2025 but rather continue from mid-December 2024 until the end of the year. Does this mean I am sometimes a bad predictor? Yes, but at least I will adjust based on new information and viewpoints in a timely manner to avoid significant losses or missed opportunities. That’s why investing in this game is so intellectually appealing.
Imagine if every golf swing resulted in a hole-in-one, every basketball shot made a three-pointer, and every shot in billiards cleared the table—life would become incredibly dull. Damn it, a life of alternating failures and successes is what makes it interesting, with a hope for more successes than failures.
