While the Biden-McCarthy meeting yesterday did not lead to an agreement on the debt ceiling in the US, it could have direct implications for the entire financial market and Bitcoin. And the implications for the Federal Reserve’s efforts to fight inflation are not overwhelming.
When the question of how the Fed will handle its failure to raise the debt ceiling came up during yesterday’s FOMC press conference, Chairman Jerome Powell was furious.
“There is only one way forward here, and that is for Congress to raise the debt ceiling so that the United States government can pay all of its obligations,” Powell said. said yesterday, further stated: “No one should assume that the Fed can protect the economy from the consequences of failing to act in a timely manner.”
Debt Ceiling Impact On Bitcoin Price
But what does it mean for the financial market and Bitcoin in particular if the debt ceiling is not raised? Jurrien Timmer, Director of Global Macro at Fidelity Investments has comments in this.
Timmer explained in a Twitter thread that the “fiscal cliff” is a “complicated dance” and can thwart the Fed’s quantitative tightening (QT) efforts. Since the Fed began squeezing liquidity through higher interest rates and QT a year ago, overall liquidity has declined.
However, liquidity has stabilized since then as the tightening has been offset by liquidity flows from reverse repos (RRP) and the Treasury General Account (TGA). Interestingly, the stock market, and Bitcoin due to its relationship with the traditional market, stopped at this point.
The chart below shows the balance sheet of the Fed (grey) and the TGA (purple). Timmer explained, “Remember how the TGA increases in 2020 because the Fed increases its balance sheet from $3.76 trillion to $8.97 trillion. Then the Treasury releases the balance of the TGA to pay the stimulus bill.
Timmer describes the relationship between the US government debt, the Fed, and the TGA as follows:
How to monetize debt? The Fed monetizes Treasury debt, in the process of generating income in the portfolio, which then goes to the TGA, which the Treasury then draws to pay its bills. Creative accounting, to say the least!
A Liquidity Rally
Ironically, Timmer said, the political squabbling over the debt ceiling would force the Treasury to drain its $569 billion TGA balance to avoid a technical default. This would be stimulative and would have a significant negative impact on the Fed’s efforts to fight inflation through QT.
As more liquidity is poured into the market, it may be “the fuel that allows the market to keep going up the wall.” On the other hand, if the debt ceiling is raised, the TGA does not need to be pulled down, which can have a negative impact on risk assets such as Bitcoin.
Currently, it is unclear when the debt ceiling will be reached in the United States. The estimate is up to the middle of this year, although the ceiling could be reached sooner, as other experts argue, pointing to the actions of the US government.
As the market thrives on expectations, and yesterday’s FOMC meeting revealed a dovish tone by the Fed (for the first time in this cycle), Bitcoin could continue its move to $25,000 if the debt ceiling debate continues over the next few weeks.
At press time, the price of Bitcoin stood at $23,761, rejected again in the important resistance zone above $24,000.
Featured images from Dave Sherrill/Unsplash, Charts from TradingView.com