The first five months of the year have been very good to asset prices, especially Bitcoin, which is currently up over 60% since the start of January. But what is the explanation for this seemingly incredible performance for the market despite the high levels of bearish sentiment from retail investors?
The Brief Summary
In January, the United States hit its debt limit, meaning the US Treasury couldn’t issue any new debt to fund the government. In this chart, you can see that every time the US reaches the debt limit, there’s a pause on the perpetually increasing national debt.
Fast forward to June, the United States has just passed an agreement to raise the debt limit and will continue to kick the can down the road, but what does this mean for stocks and crypto?
What Is The Debt Limit and How Does it Effect Markets?
First of all, in order to understand how this might affect the market, let’s look into what the debt limit means and how the national debt really works.
The debt limit describes the maximum amount of money that the federal government can borrow. This limit is signed into law by Congress. Now, at this point, the limit basically gets raised every few years in order to allow the US government to continue spending money and increasing the national debt.
How Does The Government Borrow Money?
The United States borrows money by issuing debt securities. There are basically three forms of debt securities that the United States issues.
T-Bills: short-term debt security that pays out yield upon maturity.
T-Notes: medium-term debt security that pays out yield every six months.
T-Bonds: long-term debt security that pays out yield every six months.
Now, back to the situation at hand.
Why Is The Market Up?
There are two fundamental reasons that the market is up. The first is that since the debt limit was hit in January, the United States government has not issued any new debt. This led to an increase in liquidity because the capital that would have been used to buy government debt was flowing into the market.
The above chart shows global net liquidity plotted on Bitcoin. This chart demonstrates reason number two.
As you can see in the chart, the other piece to this story is that late in 2022 and early 2023, Japan and China were pumping liquidity into the economy – i.e., expanding their central bank balance sheets. In addition to this, there was also a quick injection of liquidity from the United States central bank and the Swiss central bank – during the banking crisis. All of these events have helped the recovery in global liquidity and thus asset prices.
The United States Debt Situation
The below chart shows the US Treasury’s general account (TGA) – think of this as the government’s checking account – as well as the Fed’s reverse repurchase facilities. Reverse repurchase agreements (RRPs) are a type of short-term loan that financial institutions can use to temporarily park excess cash with the Federal Reserve.
In an RRP, the financial institution sells securities to the Federal Reserve and agrees to repurchase them at a later date at a predetermined price. The difference between the sale price and the repurchase price is the interest that the financial institution earns on the loan. We can think of this RRP balance as demand for short-term debt.
Now that the US is able to issue debt again, analysts from JPMorgan and Goldman Sachs estimate that the Treasury will begin selling about $1.1 trillion in new debt securities over the next six months or so in order to refill the Treasury General Account.
There are two ways this could go:
- If the Treasury issues medium to long-term debt, it will be more negative for liquidity in the market, and this could have a negative effect on stocks and crypto in Q3 and possibly Q4.
- However, as you can see in the chart, there is over $2 trillion parked in the Fed’s RRP facilities – demand for short-term debt – so if the Treasury issues a bunch of short-term debt such as T-Bills, there’s plenty of liquidity to absorb that debt issuance, and we might not see as negative an effect on liquidity conditions.
Central Bank Balance Sheets
We mentioned before that in late 2022 and into early 2023, we saw China and Japan’s central banks expanding their balance sheets, which has helped lead to a recovery in global liquidity – good for risk assets.
So the two other factors to take note of in terms of liquidity conditions are whether or not Japan and China continue expanding their balance sheets or begin to decrease their balance sheets.
China is actually the second-largest contributor to global liquidity, with a central bank balance sheet of over $6 trillion, just behind the US at $8.4 trillion. Since August of 2022, China’s balance sheet is up over 7%. However, since the start of the year, it’s down by 2%.
Currently, Japan’s central bank has expanded its balance sheet by 8% since September, and it’s currently at an all-time high.
Getting Into Crypto
About now, you might be asking, “Why are you always talking about macro?”
Well, we’ve said it before and will say it again, the simple answer is that most asset prices are predominantly dictated by what’s happening with global liquidity. This is because more capital in the system leads to more money going into assets, which leads to prices going up.
Bitcoin specifically is a very macro asset in terms of how much its price action is dictated by: Inflation, Interest rates, and Global liquidity. Our belief is that over time, this will only become more and more true as Bitcoin becomes a bigger part of the global economy.
This chart shows us global Net Liquidity plotted on Bitcoin. As you can see, since the end of 2022, we’ve had an easing of liquidity conditions which has helped Bitcoin recover, but unfortunately, that recovery hasn’t been very linear.
The other piece to the current story is a continued lack of liquidity in the Bitcoin Market. As you can see, since the FTX collapse, liquidity has been destroyed.
Currently, Bitcoin is consolidating in a falling wedge after failing to break its $30k resistance. The most likely scenario is that we fall to retest $24-25k.
One other chart to take note of is Bitcoin’s Short-Term Holder (STH) Realized price. This is a great indicator to watch to get a better understanding of bearishness and bullishness in the Bitcoin Market.
As you can see, in bull markets, short-term holders tend to defend their cost basis, while in bear markets, they tend to capitulate near their cost basis, aka selling at break even in order to hopefully start accumulating at a lower price.
Bitcoin’s STH Realized Price is currently near $25.5k, so as of now, we’re expecting that Bitcoin probably won’t retest below the roughly $25k level. Were we to fall back below that level, the next level we would retest is $20k, and that would put us back into the range-bound territory that Bitcoin was in from June 2022 to March 2023.
Summary
We had a good start to the year, following a recovery in global liquidity conditions. The recovery was mostly thanks to Japan and China’s central banks, as well as the US not selling any new debt.
The likely scenario is that the recovery in liquidity growth might not be as linear as markets have currently been anticipating. That being said, markets don’t always do what makes the most logical sense in the short term. So as stocks re-enter bull market territory, it’s not out of the realm of possibility that they will continue higher in the short-term if the S&P 500 breaks above its high from August 2022.
There’s no guarantee of a healthy pullback, but there is a good probability that needs to be considered. We’re currently maintaining the same longer-term bullish outlook that we’ve had so far this year.