Liquidity games
Disclaimer: This is not financial advice. Anything stated in this article is for informational purposes only, and should not be relied upon as a basis for investment decisions. Chris Keshian may maintain positions in any of the assets or projects discussed on this website.
To subscribe to my mailing list, input your email here.
In a previous post, I outlined my predictions for the high time frame accumulation range for BTC in 2023. I initially thought we would see a more protracted accumulation range between the $12k and $20k, as the market reset and the long tail of cryptoasset valuations decreased to more palatable levels.
Based on the events in the banking system over the last week, I think this range warrants revisiting. Throughout this post I will discuss what changed and how this liquidity reset might impact market participation and risk assets.
Background Context
As often troped, the Fed hikes until something breaks. The pace of rate hikes over the last year has been staggering, and a week and a half ago, something broke.
Throughout 2020 and 2021, bank deposits increased markedly because of the COVID stimulus program. Banks took these customer deposits and used them to buy long dated US Treasuries and Mortgage Backed Securities, in essence borrowing short and lending long. This would have been fine if short term rates stayed low, but as interest rates rose in response to the Fed raising its policy rate, the bond and loan portfolios of these banks incurred massive unrealized losses.
As short term interest rates increased, bank depositors realized they could find better interest than they were getting from their regional banks, so they started leaving to invest in higher yielding products like money market funds and short-term US Treasury bills.
As a result, all regional banks are now under pressure both from these unrealized losses and from the withdrawals they are experiencing in customer deposits. Add to this the rapid dissemination of information across social media and the ability to withdraw your banking deposits from your phone, and you get the classic bank run pandemonium we observed last week.
To bolster confidence in the banking system and to stem contagion, the Fed enacted the Bank Term Funding Program.Bank Term Funding Program (BTFP)
GOAL - To provide liquidity to U.S. depository institutions, each Federal Reserve Bank would make advances to eligible borrowers, taking as collateral certain types of securities.
BORROWER ELIGIBILITY - Any U.S. federally insured depository institution (including a bank, savings association, or credit union) or U.S. branch or agency of a foreign bank that is eligible for primary credit (see 12 CFR 201.4(a)) is eligible to borrow under the Program.
ELIGIBLE COLLATERAL - Eligible collateral includes any collateral eligible for purchase by the Federal Reserve Banks in open market operations (see 12 CFR 201.108(b)), provided that such collateral was owned by the borrower as of March 12, 2023. (a total of $4.4 trillion)
ADVANCE SIZE - Advances will be limited to the value of eligible collateral pledged by the eligible borrower.
RATE - The rate for term advances will be the one-year overnight index swap rate plus 10 basis points; the rate will be fixed for the term of the advance on the day the advance is made.
COLLATERAL VALUATION - The collateral valuation will be par value. Margin will be 100% of par value.
Impacts of BTFP
Under the BTFP, the Fed will print money and lend it against the banks’ pledges of UST and MBS collateral.
As described above, this lending facility could be as large as $4.4 trillion.
The Fed has been reducing the size of its balance sheet for the last year.
Last week, with the backstop of Silicon Valley Bank, the Fed effectively undid the QT progress they had made since November 2022, and the Fed balance sheet is back at November 2022 levels.
QT is the process whereby the Fed shrinks its monetary reserves by either selling Treasuries (government bonds) or letting them mature and removing them from its cash balances. This process removes liquidity, or money, from financial markets.
QE is the process whereby the Fed credits banks with reserves, and in return banks sell the Fed their UST and MBS holdings. QE adds liquidity to the financial system.
While BTFP is not directly QE, the liqudity impact is very similar, as the amount of money created by the Fed and put into circulation grows.
During COVID QE, the Fed printed $4.189 trillion.
Last week, the Fed has implicitly printed $4.4 trillion through BTFP, which will pull liquidity into the market through the following mechanism: Currently bank customers are earning ~0.5% on their deposits. As short term interest rates have increased, the yield gap between the bank deposit rate and the rate investors can earn in a Money Market fund has widened significantly. As bank depositors realize they can earn a higher yield (+4%) in a money market fund, they will continue to pull deposits from banks. As these deposits decrease, the $4.4 trillion BTFP will be pulled into the financial system to backstop bank withdrawals.
Liquidity conditions and crypto
As I discussed here, cryptoassets are highly correlated with M2. The M2 Money Supply is the measure of the money supply that can be easily converted to cash. As shown in the chart below, an expansion in the global money supply has preceded a rise in the Bitcoin price. As I indicated in my initial post on this matter, I am watching for an expansion in the global money supply as one signal that indicates more favorable conditions for risk assets.
source: gmi
Global liquidity
The 2023 spike in Global M2 shown in the above chart was primarily driven by China, as the PBOC has been easing since the start of the year. As shown below, the PBOC and BOJ tightened for several weeks in early March, but as China continues to reopen from a long lockdown I think the stimulative activity will continue.
source: Bloomberg, Fundstrat
This stance is corroborated by the PBOC recent actions to reduce the reserve requirement ratio for all banks by 25 bps, which will free up more funds for banks to lend, boosting credit growth and stimulating activity.
source: gmi
USD liquidity conditions
There are three factors that matter for USD liquidity conditions:
The size of the Fed’s balance sheet
The size of the Reverse Repo balances held at the NY Fed
The US Treasury General Account Balances with the NY Fed
Of these factors, the size of the Fed’s balance sheet is most important, and last week the Fed’s balance sheet increased markedly, as shown below.
As I described here, I use linear regression to determine which variables have the strongest impact on crypto prices. By far, the most significant factor historically has been USD liquidity conditions. As such, the above changes to global liquidity should have a positive impact on crypto prices.
A confluence trade
There are four major factors that lead me to believe there will be near term strength across the board in crypto assets.
USD Liquidity - The first of these factors is the liquidity conditions I outlined above. This has been playing out over the last week, as BTC is up ~35% in that time frame.
Whale Buys
Binance - Last Sunday, Binance signaled that they would begin converting $1B BUSD into BTC, BNB, and ETH.
Non-crypto capital inflows - Over the past week, Coinbase Institutional saw healthy net buying across a number of client segments, including traditional hedge funds, crypto native hedge funds, traditional financial institutions, and private wealth.
TA/Market Structure - While some investors disregard technical analysis, I think it is an important factor to consider when attempting to develop a comprehensive view of the market. Market structure is one way to determine the trend of the market, and its relative strength or weakness. My initial thesis was that we would develop a longer accumulation range throughout this year. That thesis was broken by the events of the last week, and it is evidence of the strength of this move and of changing market dynamics. Bitcoin just broke out of a 9-month accumulation range on the weekly chart. There are four other 6-month+ weekly range breakouts on BTC, and the subsequent price moves were, 250%, 770%, 4200%, and 470%.
Narrative Moment - Bitcoin has been in a perpetual identity crisis since its consecration. It has been described as digital gold, as an inflation hedge, as levered NASDQ beta, as sovereign money, etc… All of these identities are not compatible, but that is one thing that makes it such an interesting asset. When collective belief coalesces around one of these identities, the commensurate price moves can be significant. A long-standing Bitcoin meme is “Short the banks, long Bitcoin”. Never before has this been more poignant, and statements like the below tweet from Caitlin Long are sweeping across crypto twitter.
Price precedes narrative
I think that the recent move we have seen in Bitcoin can largely be attributed to improved liquidity conditions and whale buying. This has led to a +35% move in BTC in about a week. Rapid repricing like this attracts attention, and people often search for a simple narrative to explain these price moves.
I think the narrative that is beginning to gain traction is that of Bitcoin as digital gold - a lightweight store of wealth and alternative value transfer system that sits outside of the traditional banking system. If this wave continues, I think we will see continued strength in BTC, which will ultimately flow to the long tail of alts.
Conclusion
Based on the above analysis, I think the table has been reset, and the protracted range I was expecting this year must be reevaluated. I think likely the bottom is in for most majors in crypto, and as we progress it will become increasingly evident that the FTX implosion marked the bottom of the range for Bitcoin. As such, I am re-evaluating my purchase timeline, and looking for short term trade setups to express my evolving view. While I do still think we will range this year, that range will now likely form higher than I initially thought, and I think the case for near-term bullish momentum is quite strong.
