The US Federal Reserve (Fed) injected $29.4 billion into the banking system on Friday, sparking optimism on crypto social media. While the move aims to ease liquidity concerns and supports risky assets including Bitcoin, it is nothing out of the ordinary.
The Fed injected billions in overnight repurchase operations, the largest since the 2020 coronavirus pandemic, to ease liquidity stress that would have capped bitcoin. gains in recent weeks.
The operation, conducted through the Standing Repo Facility (SRF), temporarily increased liquidity available from primary dealers and banks and was intended to add short-term liquidity to the system, return repo rates to normal levels, prevent a sudden freeze in short-term funding markets, and give banks room to manage their reserves while the Fed monitors the situation.
This all sounds too technical, so let’s break it down to understand the connection between pensions, bank reserves, and the Fed’s latest action.
The deposit
Repurchase agreement, or repurchase agreement, is a short-term loan made overnight between two parties: one with unused cash in a bank deposit who wants to earn a return, and the other party seeking a cash loan against valuable collateral, such as securities and U.S. Treasury bills.
Both parties agree on an interest rate and the money is loaned overnight with the promise of repurchasing the asset the next day. The lenders in these transactions are typically large fund managers, such as money market funds.
Bank reserves
Repurchase transactions affect the bank’s reserves. As the lender transfers cash to the borrower, the lender’s bank’s reserves decrease, while those of the borrower’s bank increase. An individual bank is vulnerable to stress if many of its accounts lend money to borrowers at other banks.
Banks need sufficient reserves to meet regulatory requirements and conduct daily operations. They can therefore borrow reserves themselves or adjust their balance sheets as needed. And when they face a shortage, they tap the repo market or other Fed facilities such as the discount window or the supplemental financing rate (SFR).
However, when reserve shortages become severe across the system, this drives up repo rates as loanable cash becomes scarce and more borrowers compete for less cash, leading to a liquidity crunch.
This is where the Fed comes in, and that is precisely what it did on October 31st. The giant cash injection via the SRF, a tool set up to provide quick loans secured by Treasury bills or mortgage bonds, came as bank reserves fell to $2.8 trillion, pushing up repo rates.
Loanable cash had become scarce, apparently due to balance sheet runoff, known as quantitative tightening (QT), and the Treasury’s decision to increase its current account at the Fed, known as the Treasury General Account (TGA). Both took money out of the system.
Putting it all together
- Repo rates rose as loanable cash became scarce due to the Fed’s QT and Treasury liquidity buildup.
- Bank reserves have fallen below the supposed threshold of a sufficient level.
- The situation caused some stress.
- This led the Fed to inject liquidity via the SRF mechanism.
How does this affect BTC?
The $29 billion liquidity boost effectively counters the squeeze by temporarily increasing bank reserves, lowering short-term rates and easing borrowing pressures.
The move helps avoid potential liquidity crises that could harm financial markets, ultimately supporting risk assets like Bitcoin, which are considered pure fiat liquidity plays.
That said, what the Fed did on Friday does not constitute, nor suggest, imminent quantitative easing (QE), which involves direct purchases of assets by the Fed, expanding its balance to increase the overall level of liquidity in the system over months or years.
The Fed’s action on Friday represents a near-term reversible liquidity tool and is not necessarily as stimulative for risk assets as QE.
Plus, as Andy Constan, CEO and CIO of Damped Spring Advisors, said on X, everything will work itself out.
“If and only if system-wide reserves suddenly become scarce, more aggressive action by the Fed would be necessary. What’s happening is a little interbank rebalancing, a little credit stress and a little system tightening for TGA. Everything will be fine,” Constan said on X.
“If not, rates will have to stay high and rise and the SRF will have to grow quickly. Before that, it’s worth ignoring,” Constan added.
