The US Federal Reserve (Fed) pumped $29.4 billion into the banking system on Friday, sparking optimism on crypto social media. While the move was intended to ease liquidity problems and supports risk assets including bitcoin, it is nothing out of the ordinary.
The Fed pumped billions through overnight repo operations, the largest since the 2020 coronavirus pandemic, to ease liquidity stress that has reportedly put a cap on bitcoins progress in recent weeks.
The operation, conducted through the standing repo facility (SRF), temporarily increased cash available at primary dealers and banks and was intended to add short-term liquidity to the system, lower repo rates back to normal levels, prevent a sudden freeze in short-term funding markets, and give banks breathing room to manage reserves while the Fed monitors the situation.
All of this sounds too technical, so let’s break it down to understand how the repo, bank reserves, and the Fed’s latest action are connected.
The repo
The repo, or repurchase agreement, is a short-term loan made overnight between two parties – one with idle cash in a bank deposit who wants to generate returns from it, and the other party looking for a cash loan against valuable collateral, such as U.S. Treasury bonds and bills.
The two parties agree on an interest rate, and the cash is lent overnight with a promise to buy the asset back the following day. The lenders in these transactions are typically large money managers, such as money market funds.
The bank’s reserves
The repo trades affect the bank’s reserves. As the lender transfers cash to the borrower, the reserves in the lender’s bank decrease, while the reserves in the borrower’s bank increase. An individual bank is vulnerable to strains if many of its accounts lend money to borrowers at other banks.
Banks need sufficient reserves to meet regulatory requirements and carry out their day-to-day operations, so they can borrow reserves themselves or adjust their balance sheets as needed. And when they face a shortfall, they use the repo market or other Fed facilities such as the discount window or the supplementary funding rate (SFR).
But when reserve shortages become severe system-wide, it pushes up repo rates as lendable cash becomes scarce and more borrowers compete for less cash, causing liquidity to tighten.
That’s where the Fed steps in, and that’s exactly what it did on October 31st. The giant injection of liquidity through the SRF, a tool set up to provide quick loans backed by government or mortgage-backed bonds, came as bank reserves fell to $2.8 trillion, lifting repo rates.
Borrowable cash had become scarce, allegedly due to the drain on the balance sheet, called quantitative tightening (QT), and the Treasury’s decision to consolidate its checking account at the Fed, known as the Treasury General Account (TGA). Both withdrew cash from the system.
Putting it all together
- Rates rose as loanable cash became scarce due to the Fed’s build-up of QT and the Treasury.
- Bank reserves fell below the presumed threshold for ample levels.
- The situation caused quite a bit of stress.
- That led to the Fed pumping liquidity through the SRF facility
How does it affect BTC?
The $29 billion liquidity boost effectively counteracts the tightening by temporarily expanding bank reserves, lowering short-term interest rates and easing borrowing pressures.
The move helps avoid potential liquidity crises that could damage financial markets, ultimately supporting risk assets like bitcoin, which are considered pure plays on fiat liquidity.
That said, what the Fed did on Friday does not amount to or suggest imminent quantitative easing (QE), which involves outright asset purchases by the Fed expanding its balance sheet to increase the overall level of liquidity in the system over months or years.
The Fed’s action on Friday represents a reversible, short-term liquidity tool and is not necessarily as stimulative to risk assets as QE.
Besides, as Andy Constan, CEO and CIO of Damped Spring Advisors, said on X, it will all work itself out.
“If and only if system-wide reserves are indeed suddenly tight, more aggressive action by the Fed would be needed. What happens is a little interbank rebalancing and a little credit stress and a little systemic tightening for the TGA. It will all work out just fine,” said Constan at X.
“If it doesn’t, rates will have to stay high and escalate and the SRF will have to grow rapidly. Until then, it’s best to ignore,” Constan added.
