Of course, anything can happen, but overall I am bullish.
Article Author: Arthur Hayes
Source: Arthur Hayes' substack account
Article compilation: BlockBeats
In this article, Hayes analyzes how dollar liquidity affects the cryptocurrency market, particularly Bitcoin's movements, by explaining the Fed's reverse repurchase operations (RRP) and the cash flow of the U.S. Treasury account (TGA), discussing how the increase in dollar liquidity drives the rise of cryptocurrencies and stock markets. In the first quarter of 2025, about $612 billion of dollar liquidity will be injected, which may have a positive impact on the market. Finally, the author mentions that the Maelstrom fund is investing in the DeSci field and holds a bullish outlook for the future market.
The following is the original content (for ease of reading, the original content has been rearranged):
The backcountry skiing entrances in Hokkaido's ski resorts offer excellent terrain, mostly easily accessible by lifts. At the beginning of each year, ski enthusiasts are most concerned about whether there is enough snow to cover and open these entrances. A major challenge for skiers is 'sasa' (笹), which is the Japanese term for a type of bamboo plant.
The stems of this plant are as thin as reeds, but the leaves are sharp as knives, and a slight carelessness can cut the skin. Skiing on 'sasa' is very dangerous because your ski edges may slip, leading to a dangerous game I call 'man vs. tree.' Therefore, skiing in remote areas is highly risky if the snow is not deep enough to cover the 'sasa.'
This year, Hokkaido's snowfall has reached a record high in nearly 70 years, with powder snow being astonishingly deep. Therefore, the backcountry skiing entrances were opened at the end of December, whereas in previous years, they usually opened in the first or second week of January.
With the arrival of 2025, investors' focus has shifted from skiing to the cryptocurrency market, particularly whether the 'Trump rally' can continue. In my latest article (Trump Truth), I suggest that high expectations for policy actions from the Trump camp may lead to disappointment, negatively impacting the short-term market. However, at the same time, I must weigh the stimulating effect of dollar liquidity.
Currently, Bitcoin's movements fluctuate with the pace at which dollars are released, with the financial elites of the Fed and the U.S. Treasury holding the power to determine how much dollar liquidity is supplied to the global financial markets, which is a key factor affecting the market.
Bitcoin bottomed out in the third quarter of 2022 when the Fed's reverse repurchase tool (RRP) peaked. At the behest of U.S. Treasury Secretary Yellen (nicknamed 'bad girl' Yellen), the Treasury reduced the issuance of long-term coupon bonds while increasing the issuance of short-term zero-coupon bonds, thereby withdrawing over $2 trillion from the RRP.
This has effectively injected liquidity into the global financial markets. The cryptocurrency and stock markets, especially large tech stocks listed in the U.S., have surged as a result. From the above chart, we can see the relationship between Bitcoin (left axis, yellow) and RRP (right axis, white, inverted): as RRP decreases, Bitcoin prices rise.
In the first quarter of 2025, the question I am trying to answer is whether the positive stimulus of dollar liquidity can mask the potential disappointment in the pace and effectiveness of Trump's so-called 'pro-cryptocurrency' and 'pro-business' policies. If so, then market risks will become relatively controllable, and the Maelstrom fund should also increase its risk exposure.
First, I will discuss the Federal Reserve, which is a small consideration in my analysis. I will then focus on how the U.S. Treasury responds to the debt ceiling issue. If politicians delay raising the debt ceiling, the Treasury will use its funds in the ordinary account at the Fed (TGA), which will inject liquidity into the market and create positive momentum for the cryptocurrency market.
For the sake of brevity, I will not elaborate on how borrowing from RRP and TGA negatively and positively affects dollar liquidity, respectively. Please refer to the article (Teach Me, Daddy) for a detailed explanation of how these mechanisms work.
Federal Reserve
The Federal Reserve's quantitative tightening (QT) policy is advancing at a rate of $60 billion per month, meaning its balance sheet is shrinking. Currently, there has been no change in the Fed's forward guidance on the pace of QT, and I will explain the reasons in the subsequent parts of the article, but my prediction is that the market will peak in late March, thus withdrawing $180 billion of liquidity.
The reverse repurchase tool (RRP) has almost fallen to zero, and the Fed has delayed adjusting the policy interest rate of the RRP to completely exhaust the funds of this tool. At the meeting on December 18, 2024, the Fed lowered the RRP rate by 0.30%, exceeding the policy rate cut by 0.05%. This move aims to link the RRP rate to the lower bound of the federal funds rate (FFR).
If you want to understand why the Federal Reserve waited until the RRP was nearly exhausted to adjust interest rates to the lower bound of the FFR, thereby reducing the attractiveness of depositing funds into the RRP, I recommend reading Zoltan Pozar's article (Cheating on Cinderella). My conclusion from this article is that the Fed is exhausting all tools to enhance demand for U.S. Treasury issuance, avoiding a stop to QT, providing supplementary leverage ratio exemptions to U.S. commercial bank branches again, or restarting quantitative easing (QE), which is the 'reboot of the money printer.'
Currently, there are two pools of funds that will help curb the rise in bond yields. For the Fed, the 10-year U.S. Treasury yield cannot exceed 5%, as this level would trigger a significant increase in bond market volatility (MOVE index). As long as there is liquidity remaining in RRP and the Treasury General Account (TGA), the Fed will not need to make large adjustments to its monetary policy, nor will it need to acknowledge that a fiscally dominant situation is occurring.
Fiscal dominance will essentially make Powell's position subordinate to 'bad girl' Yellen, and after January 20, it will become subordinate to Scott Bessent. As for Scott, I haven't thought of a nickname that suits him. If his decisions turn me into a modern-day Scrooge McDuck due to dollar depreciation against gold, I will give him a more endearing nickname.
Once the Treasury General Account (TGA) is exhausted (positively impacting dollar liquidity) and then replenished due to the debt ceiling being hit (negatively impacting dollar liquidity), the Fed will have exhausted its emergency measures and will be unable to prevent yields from inevitably rising further after the easing cycle that began last September.
This has little effect on the dollar liquidity situation in the first quarter, but it is a reflection on how Fed policy might evolve throughout the year if yields continue to rise.
The upper limit of the federal funds rate (FFR, right axis, white, inverted) clearly shows that when the Fed lowers rates in the face of inflation above its 2% target, bond yields rise.
The real question is the speed at which the reverse repurchase tool (RRP) falls from about $237 billion to zero. I expect RRP to approach zero at some point in the first quarter, as money market funds (MMFs) withdraw funds and purchase higher-yielding Treasury bills (T-bills) to maximize returns. It should be made clear that this means $237 billion of dollar liquidity will be injected in the first quarter.
After the RRP rate change on December 18, the yield on Treasury bills (T-bills) maturing within 12 months has exceeded 4.25% (white), which is the lower bound of the federal funds rate.
The Fed will reduce liquidity by $180 billion due to quantitative tightening (QT), while an additional $237 billion of liquidity injection will occur due to the Fed's adjustment of the reward rate, which totals a net liquidity injection of $57 billion.
Treasury
'Bad girl' Yellen tells the market that she expects the Treasury to begin taking 'extraordinary measures' to fund the U.S. government between January 14 and 23. The Treasury has two options to pay government bills: either issue debt (negative for dollar liquidity) or spend funds from its checking account at the Fed (positive for dollar liquidity).
Since the total debt cannot increase before the U.S. Congress raises the debt ceiling, the Treasury can only spend funds from its checking account TGA. Currently, the TGA balance is $722 billion. The first major assumption is when the politicians will agree to raise the debt ceiling. This will be the first test of Trump's support among Republican legislators. Remember his governance margin—namely, the Republican majority over the Democrats in the House and Senate is very slim.
There is a part of the Republicans who like to puff up their chests, claiming to care about reducing the size of the bloated government every time the debt ceiling issue is discussed. They will delay voting to support raising the debt ceiling until they have secured some lucrative returns for their constituencies.
Trump has failed to persuade them to veto the spending bill for the end of 2024 unless the debt ceiling is raised. The Democrats, having experienced a 'gender-neutral bathroom' style defeat in the last election, are unlikely to help Trump unlock government funds to achieve his policy goals.
Harris 2028, are you interested? In fact, the Democratic presidential candidate will be that silver-haired gentleman Gavin Newsom. Therefore, to push things forward, Trump will wisely only include the debt ceiling issue on the agenda when absolutely necessary, before proposing any legislation.
When not raising the debt ceiling would lead to a technical default on maturing Treasury securities or a complete government shutdown, raising the debt ceiling becomes crucial. According to the Treasury's 2024 revenue and expenditure data, I estimate that this situation will occur between May and June of this year, at which point the TGA balance will be completely exhausted.
Visualizing the speed and intensity of TGA (Treasury account) usage helps predict the maximum effect moments of fund usage; the market is forward-looking. Given that this data is all public, and we know that when the Treasury cannot increase the total U.S. debt and the account is approaching exhaustion, the market will seek new sources for dollar liquidity. When the utilization rate reaches 76%, March seems to be the moment the market will ask 'when is the next time?'
If we add the total dollar liquidity from the Federal Reserve and the Treasury by the end of the first quarter, it amounts to $612 billion.
What happens next
Once default and shutdown are imminent, a last-minute agreement will be reached, and the debt ceiling will be raised. By then, the Treasury will be able to borrow again in a net borrowing manner and must refill the TGA. This will negatively impact dollar liquidity.
Another important date in the second quarter is April 15, the tax payment deadline. As seen from the above table, the government's finances significantly improve in April, which is negative for dollar liquidity.
If the factors affecting the TGA balance are the only determinants of cryptocurrency prices, I expect a local market peak to occur at the end of the first quarter. In 2024, Bitcoin reached a local high of around $73,000 in mid-March, then entered a consolidation phase, and began several months of decline before the tax payment deadline on April 11.
Trading strategy
The issue with this analysis is that it assumes dollar liquidity is the most critical marginal driver of total legal liquidity globally. Here are some other considerations:
1. Will China accelerate or slow down the creation of credit for the renminbi?
2. Will the Bank of Japan begin to raise interest rates, which would lead to the appreciation of the dollar-yen and unravel leveraged arbitrage trades?
3. Will Trump and Bessent massively devalue the dollar overnight relative to gold or other major fiat currencies?
4. How efficient is the Trump team in rapidly reducing government spending and passing legislation?
These major macroeconomic issues cannot be predetermined, but I am confident in my mathematical model of how RRP and TGA balances will change over time. My confidence is further validated, especially by the market performance from September 2022 to now: the increase in dollar liquidity due to the decrease in RRP balances directly led to the rise of cryptocurrencies and stocks, despite the Fed and other central banks raising interest rates at the fastest pace since the 1980s.
The FFR upper limit (right, green) compared to Bitcoin (right, magenta) and the S&P 500 index (right, yellow) and RRP (left, white, inverted). Bitcoin and stocks bottomed out in September 2022 and rebounded with the decline of RRP, injecting over $2 trillion of dollar liquidity into the global market. This is 'bad girl' Yellen's deliberate policy choice to withdraw RRP by issuing more Treasury bonds. Powell and his financial tightening actions to combat inflation have completely failed.
Despite various warnings, I believe I have answered the question I initially raised. That is, the disappointment in the Trump team's failure to deliver on its proposed legislation supporting cryptocurrency and business can be compensated by an extremely positive dollar liquidity environment, with dollar liquidity in the first quarter increasing by as much as $612 billion.
As is almost the case every year, it is planned that the end of the first quarter will be a time to sell, take a break, go to the beach, nightclubs, or ski resorts in the southern hemisphere, waiting for dollar liquidity conditions to improve again in the third quarter.
As the Chief Investment Officer of Maelstrom, I will encourage risk-takers in the fund to adjust their risk to 'DEGEN' (extreme risk) mode. The first step in that direction is our decision to venture into the emerging field of decentralized science (DeSci). We like undervalued junk coins and have purchased BIO, VITA, ATH, GROW, PSY, CRYO, NEURON.
To understand why Maelstrom believes the DeSci narrative could be repriced higher, please read (Degen DeSci). If things go as smoothly as I describe, I will adjust the benchmark in March and jump into the '909 open top hat' phase. Of course, anything can happen, but overall I am bullish.
Perhaps Trump's market sell-off will occur from mid-December 2023 to the end of 2024, rather than mid-January 2025. Does that mean I am sometimes a bad predictor? Yes, but at least I can absorb new information and opinions and make adjustments before they lead to significant losses or missed opportunities.
This is what makes the investment game intellectually engaging. Imagine how boring life would be if you could hole-in-one every time you hit the ball, make every three-pointer in basketball, and sink every shot in billiards.
