Source: Arthur Hayes' substack account
Author: Arthur Hayes
Compiled by: zhouzhou, BlockBeats
In this article, Hayes analyzes how dollar liquidity affects the cryptocurrency market, particularly the movements of Bitcoin, by explaining the Federal Reserve's reverse repurchase operations (RRP) and the fund flows in the Treasury General Account (TGA), exploring how the increase in dollar liquidity drives up the cryptocurrency and stock markets. In the first quarter of 2025, about $612 billion in 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 reorganized):
The remote area ski entrances of Hokkaido ski resorts offer excellent terrain, mostly easily accessible by lifts. At the beginning of each year, the main concern for skiers is whether the snow is sufficient to cover and whether these entrances can be opened. A major dilemma for skiers is 'Sasa,' 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 what I call a dangerous game of 'man vs. tree.' Therefore, if the snow is not sufficient to cover 'Sasa,' skiing in remote areas is extremely risky.
This year, Hokkaido has seen the highest snowfall in nearly 70 years, with the powder snow being impressively deep. As a result, the backcountry ski entrances opened at the end of December, whereas they usually open in the first or second week of January.
With the arrival of 2025, the focus of investors has shifted from skiing to the crypto market, particularly whether the 'Trump rally' can continue. In my latest article (Trump Truth), I suggest that the high expectations for Trump's camp's policy actions may lead to disappointment, negatively impacting the short-term market. But at the same time, I must weigh the stimulating effect of dollar liquidity.
Currently, Bitcoin's movements fluctuate with the pace of dollar release, with the financial high-ups of the Federal Reserve (Fed) and the U.S. Treasury holding the power to determine the amount of dollars supplied to global financial markets, which is a significant factor affecting the market.
Bitcoin bottomed in the third quarter of 2022 when the Federal Reserve's reverse repurchase tool (RRP) peaked. Under the push 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, thus withdrawing over $2 trillion from RRP.
This actually injects liquidity into global financial markets. The cryptocurrency and stock markets, especially large tech stocks listed in the U.S., have surged significantly as a result. As shown in the chart above, the relationship between Bitcoin (left axis, yellow) and RRP (right axis, white, inverted): as RRP decreases, the price of Bitcoin rises.
In the first quarter of 2025, the question I am trying to answer is whether the positive stimulus of dollar liquidity can overshadow the potential disappointment in the speed and effectiveness of Trump's so-called 'pro-crypto' and 'pro-business' policies. If so, market risk will become relatively controllable, and the Maelstrom fund should also increase risk exposure.
First, I will discuss the Federal Reserve, which is a minor consideration in my analysis. Then, I will focus on how the U.S. Treasury responds to the debt ceiling issue. If politicians delay raising the debt ceiling, the Treasury will draw on its funds in the Federal Reserve's general account (TGA), injecting liquidity into the market and creating positive momentum for the crypto market.
For the sake of brevity, I will not elaborate on how RRP and TGA borrowing negatively and positively impact dollar liquidity, respectively. Please refer to (Teach Me, Dad) for specifics on how these mechanisms operate.
Federal Reserve
The Federal Reserve's quantitative tightening (QT) policy is progressing at a rate of $60 billion per month, which means its balance sheet is shrinking. Currently, the Fed's forward guidance on the pace of QT has not changed, and I will explain the reasons in the later part of the article, but my prediction is that the market will peak in late March, thus drawing $180 billion in liquidity.
The reverse repurchase tool (RRP) has nearly declined to zero. To completely exhaust the funding of this tool, the Federal Reserve has delayed adjusting the RRP policy rate. At the meeting on December 18, 2024, the Federal Reserve lowered the RRP rate by 0.30%, which is 0.05% more than the decrease in the policy rate. This move aims to link the RRP rate with the lower limit of the federal funds rate (FFR).
If you want to understand why the Federal Reserve waited until RRP was nearly exhausted to adjust rates to the lower limit of the FFR, thus reducing the attractiveness of depositing funds into RRP, I recommend reading Zoltan Pozar's article (Cheating on Cinderella). My conclusion from this article is that the Federal Reserve is exhausting all tools to enhance demand for U.S. Treasury issuance, avoiding the cessation of QT, providing supplemental leverage exemptions for U.S. commercial bank branches, or restarting quantitative easing (QE), i.e., 'restarting the printing press.'
Currently, there are two pools of funds that will help curb the rise in bond yields. For the Federal Reserve, the 10-year U.S. Treasury yield cannot exceed 5%, as this level would trigger a significant rise in bond market volatility (MOVE index). As long as there is liquidity in RRP and the Treasury General Account (TGA), the Federal Reserve does not need to make significant adjustments to its monetary policy, nor does it have to acknowledge that a fiscal dominance situation is occurring.
Fiscal dominance will essentially make Powell's position subordinate to 'Bad Girl Yellen', and after January 20, it will be subordinate to Scott Bessent. As for Scott, I haven't thought of a suitable nickname for him yet. If his decisions turn me into a modern-day Scrooge McDuck due to the depreciation of the dollar against gold, I will give him a more likable nickname.
Once the Treasury General Account (TGA) is exhausted (which positively impacts dollar liquidity), it will subsequently be replenished after the debt ceiling is reached and lifted (which negatively impacts dollar liquidity), the Federal Reserve will have exhausted its emergency measures and will be unable to prevent yields from rising further after the easing cycle that began last September.
This has little effect on the dollar liquidity situation in the first quarter, just a reflection on how the Federal Reserve's policy might evolve over the year if yields continue to rise.
The federal funds rate upper limit (FFR, right axis, white, inverted) compared to the 10-year U.S. Treasury yield (left axis, yellow) clearly shows that while the Federal Reserve is lowering rates in the face of inflation above its 2% target, bond yields are rising.
The real issue is the speed at which the reverse repurchase tool (RRP) declines 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 needs to be particularly clear that this means an injection of $237 billion in dollar liquidity 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 limit of the federal funds rate.
The Federal Reserve will reduce liquidity by $180 billion due to quantitative tightening (QT), while the reduction in RRP balances due to adjustments in the Fed's reward rates will further push an injection of $237 billion in liquidity. This means a total net liquidity injection of $57 billion.
Treasury
'Bad Girl' Yellen has told 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 (which negatively impacts dollar liquidity) or spend funds from its checking account at the Federal Reserve (which positively impacts dollar liquidity).
Since the total debt cannot increase until 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 big assumption is when politicians will agree to raise the debt ceiling. This will be the first test of Trump's support among Republican legislators. Remember his governance margins — the Republican majority over the Democrats in the House and Senate is very slim.
There is a portion of Republicans who like to puff out their chests and strut around, 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 secure some hefty returns for their constituencies.
Trump has failed to convince them to veto the spending bill at the end of 2024 if the debt ceiling is not raised. Democrats are less likely to help Trump unlock government funding to achieve his policy goals after experiencing a 'gender-neutral restroom' style defeat in the last election.
Harris 2028, is everyone interested? In fact, the Democratic presidential candidate will be that silver-haired man Gavin Newsom. Therefore, to push things forward, Trump will wisely delay putting the debt ceiling issue on the agenda until absolutely necessary before proposing any legislation.
Raising the debt ceiling becomes crucial when not raising it leads to technical defaults on maturing Treasuries or a complete government shutdown. Based on the Treasury's published 2024 revenue and expenditure data, I estimate this situation will occur between May and June this year, when the TGA balance will be completely exhausted.
Visualizing the speed and intensity of TGA (Treasury Account) usage helps predict the maximum effect moments for fund usage, as the market is forward-looking. Given that this data is public, and we know that when the Treasury cannot increase the total U.S. debt and the account is close to exhaustion, the market will look for new sources to obtain 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 up the total dollar liquidity from the Federal Reserve and the Treasury by the end of the first quarter, it totals $612 billion.
What happens next?
Once default and shutdown are imminent, a last-minute agreement will be reached to raise the debt ceiling. By then, the Treasury will be able to borrow again on a net basis and will have to refill the TGA. This will negatively impact dollar liquidity.
Another important date in the second quarter is April 15, the tax deadline. As seen in the above table, government finances improve significantly 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 top by the end of the first quarter. In 2024, Bitcoin reached a local high of about $73,000 in mid-March, then entered a consolidation phase and began a months-long decline before the tax deadline on April 11.
Trading Strategy
The problem with this analysis is that it assumes dollar liquidity is the most critical marginal driver of global total legal liquidity. Here are some other considerations:
Will China accelerate or slow down the creation of renminbi credit?
Will the Bank of Japan start raising interest rates, which would appreciate the dollar-yen exchange rate and unravel 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 reducing government spending and passing legislation?
These major macroeconomic issues cannot be predetermined, but I am confident in the mathematical model of how RRP and TGA balances change over time. My confidence is further validated, especially by the market performance from September 2022 to now: the increase in dollar liquidity directly caused by the decline in RRP balances has led to a rise in cryptocurrencies and stocks, despite the Federal Reserve and other central banks raising interest rates at the fastest pace since the 1980s.
The FFR cap (right side, green) compared to Bitcoin (right side, magenta) and the S&P 500 index (right side, yellow) and RRP (left side, white, inverted). Bitcoin and stocks bottomed in September 2022 and rebounded driven by the decline in RRP, injecting over $2 trillion in dollar liquidity into the global market. This was a deliberate policy choice by 'Bad Girl' Yellen to withdraw RRP by issuing more Treasury bonds. Powell and his monetary tightening actions to combat inflation have completely failed.
Despite various warnings, I believe I have answered the question I initially posed. That is, the disappointment in the Trump team's failure to deliver on its proposed legislation supporting cryptocurrencies and businesses 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 almost every year, as planned, the end of the first quarter will be the time to sell, take a break, and go to the beach, nightclubs, or ski resorts in the Southern Hemisphere, etc., and wait for the 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 this direction was our decision to enter the emerging decentralized science (DeSci) field. We like undervalued junk coins and have purchased BIO, VITA, ATH, GROW, PSY, CRYO, and NEURON.
To understand why Maelstrom believes the DeSci narrative could be repriced higher, read (Degen DeSci). If things go as smoothly as I describe, I will adjust the benchmark in March and jump into the '909 Open High Hat' phase. Of course, anything can happen, but overall I am bullish.
Perhaps the market sell-off by Trump occurs between mid-December 2023 and the end of 2024, rather than mid-January 2025. Does that mean I am sometimes a poor 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 why the investment game is intellectually engaging. Imagine how boring life would be if every time you hit the ball, you made a hole-in-one, every three-pointer in basketball went in, and every shot in billiards sunk.
