Analysis of Dollar Liquidity and Crypto Assets Market Trends

As 2025 approaches, investors' focus has shifted from skiing to the crypto market, especially whether the "certain political figure's market" can sustain itself. In my previous article, I mentioned that the market's high expectations for certain policy actions could lead to disappointment, negatively affecting the short-term market. However, I must also weigh the stimulating effect of the dollar's liquidity.

Currently, the trend of Bitcoin fluctuates with the rhythm of the dollar's release. The financial elites of the Federal Reserve and the U.S. Treasury hold the power to decide the quantity of dollars supplied to the global financial market, which is an important factor influencing the market.

Bitcoin bottomed out in the third quarter of 2022, when the Federal Reserve's reverse repurchase agreement (RRP) peaked. At the urging of the U.S. Secretary of the Treasury, the U.S. 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 actually injected liquidity into the global financial markets. Crypto Assets and stock markets, especially large tech stocks listed in the United States, have surged as a result. The chart shows the relationship between Bitcoin and RRP: as RRP decreases, Bitcoin prices rise.

In the first quarter of 2025, the question I tried to answer is whether the positive stimulus of USD Liquidity can mask potential disappointment in the speed and effectiveness of certain policies. If so, then market risk will become relatively controllable, and our fund should also increase its risk exposure.

First, I will discuss the Federal Reserve, which is a minor consideration in my analysis. Subsequently, I will focus on how the U.S. Treasury responds to the debt ceiling issue. If politicians delay in raising the debt ceiling, the Treasury will draw on its funds in the Federal Reserve's General Account (TGA), which will inject liquidity into the market and create positive momentum for the crypto market.

Federal Reserve

The Federal Reserve's quantitative tightening (QT) policy is progressing at a pace of $60 billion per month, which means its balance sheet is shrinking. Currently, there has been no change in the Fed's forward guidance on the pace of QT. I will explain the reasons later in the article, but my prediction is that the market will peak in late March, therefore $180 billion of Liquidity will be withdrawn.

The reverse repurchase agreement tool (RRP) has nearly fallen to zero, and in order to completely exhaust the funding of this tool, the Federal Reserve has adjusted the RRP policy interest 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 to the lower bound of the federal funds rate (FFR).

Currently, there are two funds that will help suppress the rise in bond yields. For the Federal Reserve, the yield on the 10-year U.S. Treasury bond cannot exceed 5%, as this level would trigger a significant increase in bond market volatility. As long as there is liquidity in the 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-led situation is occurring.

Once the Treasury General Account (TGA) is depleted (which has a positive impact on dollar Liquidity), and then replenished due to the debt ceiling being raised (which has a negative impact on dollar Liquidity), the Federal Reserve will exhaust its emergency measures and will be unable to prevent yields from inevitably rising further after the easing cycle that began last September.

The upper limit of the federal funds rate (FFR) and the yield on the 10-year U.S. Treasury bond clearly show that when the Federal Reserve lowers interest rates in the face of inflation above its 2% target, bond yields rise.

The real issue is the pace at which reverse repurchase agreements (RRP) have fallen from about $237 billion to zero. I expect RRP to be close to zero at some point in the first quarter as money market funds (MMF) withdraw funds and purchase higher-yielding Treasury bills (T-bill) to maximize returns. It needs to be made particularly clear that this means there will be 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%, 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 an additional $237 billion of Liquidity injection will be driven by the reduction in RRP balances resulting from the Fed's adjustment of the reward rate. This totals a net Liquidity injection of $57 billion.

Ministry of Finance

The Treasury Secretary 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 has a negative impact on dollar Liquidity) or draw funds from its checking account at the Federal Reserve (which has a positive impact on dollar Liquidity).

Due to the total debt not being able to increase before the debt ceiling is raised by the U.S. Congress, the Treasury can only spend funds from its checking account TGA. Currently, the balance of TGA is $722 billion. The first major assumption is when politicians will agree to raise the debt ceiling. This will be the first test of support for a political figure among Republican lawmakers.

Some politicians like to puff out their chests and act high and mighty. Every time the debt ceiling issue is discussed, they claim to care about reducing the size of the bloated government. They will delay voting to support an increase in the debt ceiling until they secure some hefty returns for their constituencies.

When not raising the debt ceiling could lead to a technical default on maturing government bonds or a complete government shutdown, raising the debt ceiling becomes crucial. According to the 2024 revenue and expenditure data released by the Treasury, I estimate that this situation will occur between May and June of this year, when the TGA balance will be completely depleted.

Visualizing TGA (Treasury General Account) usage speed and intensity helps predict the optimal moments for maximizing the effects of fund usage, as the market is forward-looking. Given that this data is all public, and we know that when the Treasury cannot increase the total amount of U.S. debt and the account is nearing depletion, the market will look for new sources to obtain dollar Liquidity. At a usage rate of 76%, March seems to be the moment when the market will ask "What's next?".

If we add the total dollar liquidity of the Federal Reserve and the Treasury by the end of the first quarter, it amounts to 612 billion dollars.

What will happen next?

Once the 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 on a net borrowing basis and must replenish the TGA. This will have a negative impact on dollar liquidity.

Another important date in the second quarter is April 15, when taxes are due. As seen from the table above, government finances improved significantly in April, which is a negative for USD Liquidity.

If the only factor affecting the TGA balance is the sole determinant of Crypto Assets prices, then I expect a local market top to occur by 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 a several-month decline before the tax deadline on April 11.

Trading Strategy

The problem with this analysis is that it assumes that US 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 credit for the Renminbi?
• Will the Bank of Japan start raising interest rates, which would lead to an appreciation of the USD/JPY and unwind leveraged arbitrage trades?
• Will some policymakers conduct large-scale overnight depreciation of the US dollar relative to gold or other major fiat currencies?
• How efficient are certain teams 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 decline in RRP balances and the subsequent increase in dollar Liquidity directly led to the rise of Crypto Assets and stocks, despite the Federal Reserve and other central banks raising interest rates at the fastest pace since the 1980s.

The FFR upper limit compared to Bitcoin, the S&P 500 index, and RRP. Bitcoin and stocks bottomed in September 2022 and rebounded with the decline in RRP, as over $2 trillion in dollar liquidity was injected into global markets. This was a deliberate policy choice by policymakers to withdraw RRP by issuing more government bonds. The financial tightening actions completely failed.

Despite various warnings, I believe I have answered the question I initially posed. That is to say, the disappointment that certain teams have failed to deliver on the legislation proposed to support Crypto Assets and business can be offset by an extremely positive environment of dollar Liquidity, with an increase in dollar Liquidity reaching up to $612 billion in the first quarter.

As with almost every year, as planned, the end of the first quarter will be the time to sell, take a break, go to the beach, nightclubs, or ski resorts in the Southern Hemisphere, and wait for the liquidity conditions of the US dollar to improve again in the third quarter.

As the Chief Investment Officer of the fund, I will encourage risk-takers in the fund to adjust their risk to the "DEGEN" (extreme risk) mode. The first step in this direction is our decision to venture into the emerging field of decentralized science (DeSci). We like undervalued digital assets and have purchased BIO, VITA, ATH, GROW, PSY, CRYO, NEURON.

If things go as smoothly as I described, 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 some market sell-offs will occur from mid-December 2023 to the end of 2024, rather than mid-January 2025. Does that mean I can sometimes be a bad forecaster? 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 so intriguing. Imagine if every time you hit the ball, you got a hole in one, every three-pointer in basketball went in, and every shot in billiards went in; life would be so dull.