Analysis of the Impact of US Dollar Liquidity on the Crypto Assets Market

The remote ski entrances of Hokkaido's ski resorts are renowned for their excellent terrain, most of which can be easily accessed by cable cars. At the beginning of each year, ski enthusiasts are most concerned about whether the snowfall is sufficient to cover these entrances. For skiers, a major challenge is "sasa", a type of sharp-stemmed bamboo plant. When the snowfall is insufficient to cover the "sasa", skiing in remote areas becomes highly risky.

This year, the snowfall in Hokkaido has reached a new high in nearly 70 years, with an astonishing depth of powder snow. As a result, the ski entrance in the back mountains opened at the end of December, whereas in previous years it typically opened in the first or second week of January.

As 2025 approaches, investors' focus has shifted from skiing to the crypto market, particularly whether the so-called "Trump market" can continue. In the latest analysis, I suggest that the market's high expectations for the Trump camp's policy actions could lead to disappointment, negatively impacting the short-term market. However, I must also weigh the stimulating effect of dollar Liquidity.

Currently, the trend of Bitcoin fluctuates with the rhythm of the dollar's release. The financial executives of the Federal Reserve and the U.S. Treasury hold the power to decide the amount of dollars supplied to the global financial market, which is a key factor affecting the market.

Bitcoin bottomed out in the third quarter of 2022, when the Federal Reserve's reverse repurchase agreement (RRP) peaked. Driven by the Treasury, the U.S. Department of the Treasury reduced the issuance of long-term coupon bonds while increasing the issuance of short-term zero-coupon bonds, thereby extracting over $2 trillion from the RRP. This effectively injected liquidity into the global financial markets, leading to a significant rise in Crypto Assets and the stock market, especially for large tech stocks listed in the U.S.

In the first quarter of 2025, the question I tried to answer is whether the positive stimulus of the US dollar Liquidity can mask the potential disappointment in the implementation speed and effectiveness of Trump's so-called "pro-Crypto Assets" and "pro-business" policies. If so, then market risk will become relatively controllable.

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

The Federal Reserve's quantitative tightening (QT) policy is advancing at a pace of $60 billion per month, which means that the size of its balance sheet is shrinking. Currently, there has been no change in the Fed's forward guidance on the speed of QT. I predict that the market will peak in mid to late March, thus $180 billion of Liquidity will be withdrawn.

The reverse repurchase agreement (RRP) tool has almost been reduced to zero. To completely exhaust the funding of this tool, the Federal Reserve 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 decline in the policy rate. This move aims to link the RRP rate to the lower limit of the federal funds rate (FFR).

Currently, there are two liquidity pools that will help curb 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.

Once the Treasury General Account (TGA) is depleted (which has a positive impact on USD liquidity), it will then be replenished after being raised due to the debt ceiling being reached (which has a negative impact on USD 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 in September of last year.

I expect the 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. This means that $237 billion of dollar liquidity will be injected in the first quarter.

The Federal Reserve will reduce Liquidity by $180 billion due to Quantitative Tightening (QT), while an additional $237 billion Liquidity injection will be driven by a reduction in RRP balances due to adjustments in reward rates by the Federal Reserve. This totals to a net Liquidity injection of $57 billion.

The Treasury has two options to pay government bills: either issue debt (which has a negative impact on dollar Liquidity) or spend funds from its checking account at the Federal Reserve (which has a positive impact on dollar Liquidity). Since the total amount of debt cannot be increased until Congress raises the debt ceiling, the Treasury can only spend funds from its TGA checking account. Currently, the balance of the TGA is $722 billion.

Trump will wisely include the debt ceiling issue on the agenda only when absolutely necessary, before proposing any legislation. It becomes crucial to raise the debt ceiling when not raising it would lead to a technical default on maturing government bonds or a complete government shutdown. According to the fiscal data released by the Treasury for 2024, I estimate that this situation will occur between May and June of this year, when the TGA balance will be completely depleted.

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.

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. Government finances improved significantly in April, which is negative for dollar liquidity.

If the factors affecting the TGA balance are the only determinants of Crypto Assets prices, then I expect a local market top to appear by the end of the first quarter. In 2024, Bitcoin reached a local high of about $73,000 in mid-March, then entered a period of consolidation, and began a months-long decline before the tax deadline on April 11.

This analysis assumes that the liquidity of the US dollar is the most critical marginal driver of global total fiat liquidity. There are other factors to consider, such as the speed of credit creation in China's renminbi, the possibility of interest rate hikes by the Bank of Japan, the Trump administration's policy of devaluation of the dollar, as well as the reduction in government spending and the efficiency of bill passage.

Despite various uncertainties, I believe that the extremely positive dollar Liquidity environment can compensate for any disappointments that the Trump team may have in supporting Crypto Assets and business legislation, with the increase in dollar Liquidity in the first quarter reaching as much as $612 billion.

As the Chief Investment Officer of a certain fund, I will encourage the risk-takers in the fund to adjust their risk to an extremely high mode. We have decided to venture into the emerging field of decentralized science (DeSci) and have purchased some related tokens.

Overall, I am optimistic about the market. Perhaps Trump's market sell-off will happen 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 why investment games are so captivating. Imagine 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 was successful; how dull life would be.