Treasury Liquidity Fueling Bitcoin’s Rally

Bitcoin appears to have found a new macro catalyst. After languishing around $60K-$65K for weeks, BTC▲$62,630.00exploded past $70,000 when the U.S. Treasury announced support for the government bond market. That means Treasury liquidity may be becoming a critical driver of crypto prices.

What Is Treasury Liquidity?

When discussing Treasury liquidity, there are actually two separate concepts.

The first refers to the general liquidity of the Treasury market: that is, how easily one can buy or sell government bonds for a given size trade without sharply affecting the price.

Meanwhile, the second concept refers to broader dollar liquidity in the financial system.

When the Treasury market becomes stressed, yields tend to rise, making bonds more attractive than other assets like Bitcoin, real estate, or stocks. Higher yields also tighten financial conditions for leveraged investors.

On the other hand, when Treasury market liquidity improves, the opposite can occur: yields fall, and the relative value of other assets rises.

Why Treasury Liquidity Helped Bitcoin Rally

This time, the catalyst was the former: liquidity in the long-end of the Treasury market.

The Treasury announced it would increase the size of liquidity-support buybacks for the 10-to-20-year and 20-to-30-year segments: from a maximum of $2 billion to at least $4 billion per operation from September 9 through November 4.

After the announcement, the 30-year yield climbed past 5.3%, the highest level since 2007, while the 10-year yield approached 4.7%.

The 10-year yield subsequently fell back to around 4.64%, the 30-year yield to 5.19%. Bitcoin promptly jumped from around $64,000 toward $70,000 – helped along the way by both a broader market rally and heavy short liquidation.

The higher the yields, the higher their opportunity cost; conversely, lower yields reduce this cost and serve as a catalyst for demand.

In this way, improved liquidity in the Treasury market can act as a proxy for eased financial conditions, even if the Federal Reserve is not explicitly cutting rates.

Treasury Buybacks Are Not Quantitative Easing

It is also worth highlighting the critical difference between what the Treasury and the Federal Reserve are doing.

When the Fed conducts quantitative easing (QE), it is essentially printing money and buying assets in order to add liquidity to the financial system and ease monetary conditions.

Furthermore, as the Treasury itself notes, “these buybacks are not expected to have a significant impact on net marketable borrowing” by the U.S. government, since the buybacks are generally offset by other issuances.

The Treasury General Account Could Actually Drain Liquidity

It is also vital to understand that not all movements in the Treasury liquidity space are bullish for Bitcoin.

To highlight one example, the Treasury General Account (TGA) acts as the government’s checking account at the Federal Reserve.

When the TGA spends money, that liquidity enters the broader financial system; by contrast, when the government issues debt to replenish the TGA, the opposite is true: liquidity is removed from the system.

The TGA peaked at around $929 billion in early-August, before falling back to around $870 billion at the time of writing.

It is worth noting that the Treasury currently expects to hold around $950 billion balance at the end of September and estimates that the account could peak around $1.05 trillion, plus or minus $50 billion, in the TGA as of late-October.

And that could have negative implications for asset prices, and Bitcoin in particular.

Treasury Issuance Matters for Bitcoin

The Treasury expects to raise approximately $739 billion in privately held net marketable debt during the July–September quarter, followed by another $628 billion in net revenues from issuances in October-December.

The mix of short- and long-dated bonds matters.

The former tend to impact liquidity in the Treasury market as well as the broader financial system, while the latter can tighten financial conditions by reducing the supply of bonds at shorter maturities.

As for Bitcoin, the critical question is where the money raised by the Treasury will come from.

If most of it is spent on already existing cash balances in reserve, the impact on the broader financial system will be comparatively limited.

Conversely, if large-scale withdrawals from bank reserves are required to fund the Treasury borrowing needs, the impact on liquidity can be viewed as contractionary.

The same logic applies to the TGA and the broader economy as whole.

These nuances help explain why Bitcoin and the broader market can respond so differently to large-scale Treasury liquidity operations, depending on the context.

The Reverse Repo Buffer Is Smaller Than Before

It is also worth discussing the reverse repo buffer, which has proven critical to a number of previous crypto cycles.

The reverse repo buffer has since been depleted: the facility peaked at over $2 trillion at the height of the pandemic, but has since fallen sharply.

As of now, total reverse repos for the entire Federal Reserve only stand at around $319 billion in early August. Bank reserve balances were roughly $3 trillion, down from a peak of over $10 trillion at the peak of the pandemic.

The importance of following the government’s financing calendar may be comparable to watching the Federal Reserve’s statements about monetary policy.

Why Bond Yields May Matter More Than the Buybacks

Ultimately, yields may prove a more critical barometer for forecasting Bitcoin’s movements.

A 30-year bond with a yield of over 5% is extremely attractive to investors who seek yield, which makes the long-end of the yield curve especially important to cryptocurrencies.

After all, a substantial portion of crypto-asset owners are yield-seeking investors, which means high bond yields are inherently bullish for demand – provided the alternative options carry similar risk parameters.

At the same time, rising yields can tighten financial conditions by increasing the cost of financing for mortgages, corporate bonds, and – by extension – digital assets.

The recent rally illustrates the opposite phenomenon: with the announcement of improved Treasury liquidity, the yield curve flattened, the dollar softened, and risk assets were quick to respond.

If this trend continues, yields – and Treasury liquidity in general – can act as a consistent tailwind for Bitcoin.

However, if long-duration bond yields rise rapidly, or if the long-end of the yield curve once again enters a selling mode, the situation could quickly reverse.

What Could Make Treasury Liquidity Bullish for Bitcoin?

A number of factors could make Treasury liquidity a consistent catalyst for Bitcoin’s gains.

Foremost, the Treasury can always restart its liquidity operations and continue to support the bond market.

The government can also reduce its financing needs at shorter maturities, and increase issuance at longer dated segments in order to reduce the impact on the yield curve.

The TGA – and, by extension, the cash on deposit at the Federal Reserve – can also shrink, injecting additional liquidity into the economy.

Finally, the Federal Reserve can ease monetary policy and begin cutting rates – or re-starting bond-buying operations.

In essence, a combination of falling yields, a weaker dollar, and increased liquidity in the broader financial system would constitute a perfect storm for Bitcoin.

Could Treasury Liquidity Reverse Again?

Despite the recent intervention, the fundamental drivers of the bond market remain in place: the Treasury still needs to raise enormous amounts of cash, and the government’s liabilities greatly exceed the rate at which it can pay them back. A sharp rise in inflation could also cause long-duration yields to rise, negating the benefits of improved Treasury liquidity.

The interventions may also fail to take into account the market realities.

While $4 billion in liquidity improvements can ease stress in specific segments of the bond market, broader financial conditions may deteriorate due to increased issuance, TGA demand, or other factors.

It is not impossible that the recent improvements in liquidity will be reversed in the months ahead, with the Treasury market re-entering a stress period.

Is Treasury Liquidity Fueling Bitcoin’s Rally?

It appears to have contributed to the recent one, but it is still too early to declare a lasting liquidity cycle.

Following the Treasury announcement, Bitcoin rose sharply, and appears to have entered a new uptrend. Higher Treasury liquidity helped reduce long-duration yields, lower the value of the dollar, and catalyze a wider risk-on move in financial markets. Meanwhile, short liquidation further added to Bitcoin’s gains.

If yields and, by extension, the dollar decline, while the TGA and the broader financial system gain liquidity, the combined impact on Bitcoin could be significant.

Conversely, should yields rise sharply, or if Treasury liquidity fails to offset additional tightening in financial conditions, the positive impact on Bitcoin may well be short-lived.

The US bond market appears to be one of the most critical variables for forecasting crypto prices.

Treasury liquidity can refer to a variety of factors, but it generally describes the ability to buy and sell government bonds, as well as broader dollar liquidity affected by government borrowing, spending, the Treasury General Account and other factors.

Why does Treasury liquidity affect Bitcoin?

Improving Treasury liquidity can reduce pressures on the bond market and ease financial conditions, indirectly benefitting other asset classes such as Bitcoin.

Are Treasury buybacks the same as quantitative easing?

Not quite – while quantitative easing generally targets broader liquidity conditions, Treasury buybacks generally target specific segments of the Treasury market.

Why did Bitcoin rally after the Treasury buyback announcement?

Bitcoin rallied as the Treasury doubled planned long-duration bond buybacks, causing Treasury yields to fall and risk appetite to improve.

Short liquidation also contributed to the rally.

Could Treasury liquidity push Bitcoin above $70,000?

It could, but heavy government borrowing, inflation and higher long-duration yields could well offset further improvements in Treasury liquidity.

Source: bitcoinfoundation.org