The U.S. Federal Reserve cut interest rates by 25 basis points last week, but that may not have been the biggest news to bitcoin BTC$87,491.03 bulls. The real surprise was the central bank’s announcement to start 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 Fed’s balance sheet, much as the 2020 Covid-era quantitative easing (QE) program and the post-global financial crisis maneuvers that fueled unprecedented risk-taking across financial markets, including in digital assets.
Not so fast, suggests popular pseudonymous observer Conks, known for his in-depth macro insights. In a blog post published Monday, Conks argued that while the latest operation looks similar to QE, it’s really not. The Fed action this time around aims to ensure 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 long term.
The program is not intended to stimulate the economy or markets, which is where previous QE programs were aimed.
In short, the central bank is adding liquidity, not stimulus.
For the moment, markets seems to agree. Bitcoin knee-jerked higher for a few minutes after the Fed announcement, but it’s been headed lower ever since, now off about 7% since at $87,000.
“[Latest] Asset purchases will be devoid of any meaningful easing outside money markets,” wrote Conks. “Equities will need to rely on other forces to further climb the wall of worry.”
What’s actually happening
The Fed’s decision to buy short-term bills comes as bank reserves, the cash deposits of commercial banks at the Fed, recently got too low. When reserves dwindle, interest rates banks charge each other overnight in the money market jump, causing financial tightening and threatening stability.
The total amount of reserves fell below $3 trillion, the supposed ample level, in late October, causing a notable rise in those rates.
The Fed’s bill buying will boost cash (reserves) in the banking system, increasing liquidity and reducing the cost of interbank borrowing. This, in turn, ensures the smooth functioning of the money market.
However, this does not really bring down longer-duration interest rates, which is thought to be necessary to stimulate borrowing and investing in the economy and to galvanize risk-taking in markets. The QE implemented post-2008 and in 2020 involved the Fed buying longer-term Treasury notes and mortgage-backed securities, which pushed the 10-year yield to unprecedently low levels.
Hence, it’s not surprise that the Fed is calling its latest program RMO – Reserve Management Operations – rather than QE.
Pre-emptive strike
According to Conks, the RMOs seem to be a pre-emptive move against the possibility of stress emerging in coming months, especially in April when the Treasury faces a massive quarterly tax payment deadline.
Around mid-April, millions of businesses and individuals pay estimated taxes to the IRS all at once, pulling out hundreds of billions in cash from money market funds and short-term funding systems as they sell assets or drain deposits.
“As revealed by Chair Powell in the latest FOMC presser, officials will imminently deploy reserve injections to build up a cushion against several incoming “blindspots” arising from a volatile TGA, the big risk centered around April’s infamous tax day,” Conks said. “Following this year’s interbank flows threatening to induce numerous blindspots, the Fed — now much closer to the system’s lowest comfortable level of reserves (LCLoR) — won’t take any chances.”
In short, the Fed does not want to face another September 2019 like event when short-term borrowing rates spiked hard because reserves got too low, shaking the system. It is thus front-loading liquidity injections with $40 billion in bill purchases per month.
What this means for markets?
What looks like QE is really a maintenance operation aimed at ensuring smooth functioning of the financial system. The Fed doesn’t appear to be aiming to juice asset prices or drive growth — it’s making sure the pipes don’t clog as reserves fluctuate.
That said, the Fed action does eliminate the risk of sudden spike in interbank lending rates and panic in financial markets.In other words, it has removed a major uncertainty or potential headwind for risk assets, including bitcoin.
