Arthur Hayes: When Will This Market Cycle Peak and What Trading Strategies Should Be Adopted?
The remote regions of Hokkaido's ski resorts offer excellent terrain, most of which is accessible by cable car. Early in the ski season, the key question for skiers is when there will be enough snow for the slopes to open. A challenge arises when the bamboo thickets in these areas remain exposed. These bamboo stems, though thin and reed-like, are covered with sharp green leaves that can cut your skin if you're not careful. Skiing through such thickets is hazardous, as your edges might slip, plunging you into what I call a "man versus tree" game. Therefore, if the snow is insufficient to cover the bamboo, these remote regions remain perilous.
Hokkaido has seen unprecedented snowfall this season, the heaviest in nearly 70 years. The snow is deep, and as a result, the backcountry gates opened in late December instead of the usual first or second week of January.
As we step into 2025, cryptocurrency investors are wondering whether the policies Donald Trump aims to implement will have staying power. In my recent article, "Arthur Hayes: How Trump's New Policies and Global Reactions Will Impact Crypto", I discussed how high expectations for Trump’s administration’s pro-crypto and pro-business moves could lead to market disappointment. While I still see this as a potential short-term headwind, I must balance this view with the liquidity impulse from the dollar. For now, Bitcoin’s trajectory will be influenced by shifts in the pace of dollar issuance, dictated by the monetary officials at the Federal Reserve (Fed) and the U.S. Treasury, who control the global financial market's supply of dollars.
Bitcoin bottomed out in Q3 2022, coinciding with the Federal Reserve's reverse repurchase (RRP) facility peaking. At the request of Treasury Secretary Janet Yellen (Bad Gurl Yellen), the Treasury issued fewer long-term coupon bonds and more short-term zero-coupon bills, withdrawing over $2 trillion from the RRP facility. This injected liquidity into the global financial markets, boosting assets like cryptocurrency, particularly U.S.-listed tech stocks. The chart above shows Bitcoin (LHS, yellow) versus the RRP facility (RHS, white, inverted); as the RRP balance decreased, Bitcoin rose.
The question I aim to address is whether the positive dollar liquidity impulse in Q1 2025 can offset market disappointment regarding the speed and impact of Trump's so-called pro-crypto and pro-business policies. If the answer is yes, it might be time to ramp up risk exposure, as the Maelstrom strategy takes on more risk in its portfolio.
First, I will discuss the Federal Reserve, which plays a secondary role in my analysis. Then, I will delve into how the Treasury will handle the debt ceiling. If politicians hesitate to raise the debt ceiling, the Treasury will reduce its general account (TGA) at the Fed, injecting liquidity into the system and creating a positive momentum for cryptocurrencies.
For brevity, I won’t elaborate on why RRP and TGA balances represent negative and positive dollar liquidity, respectively.
The Federal Reserve
The Fed’s quantitative tightening (QT) policy is continuing at a pace of $60 billion per month, reducing its balance sheet. The Fed has not changed its forward guidance regarding QT. My forecast, which I will elaborate on later, is that the market will peak around mid to late March, meaning QT will drain $180 billion in liquidity between January and March.
The RRP balance has dropped to nearly zero. To fully deplete this tool, the Fed belatedly adjusted the policy rate for RRP. On December 18, 2024, the Fed lowered the RRP rate by 0.30%, more than the 0.05% reduction in the policy rate. This aligns the RRP rate with the lower bound of the federal funds rate (FFR).
If you’re wondering why the Fed waited until the RRP was nearly exhausted to align its rate with the lower bound of the FFR and reduce the attractiveness of depositing funds into this tool, I encourage you to read Zoltan Pozsar’s essay "Fooled by Cinderella". My takeaway from his article is that the Fed is exhausting all measures to stimulate demand for U.S. Treasury issuance before resorting to halting QT, reintroducing supplementary leverage ratio exemptions for U.S. commercial banks, and possibly restarting quantitative easing (QE)—aka turning the money printer back on.
For now, two liquidity pools help control bond yields. The 10-year U.S. Treasury yield cannot surpass 5%, as this is the threshold for volatility explosions in the bond market (MOVE index). As long as liquidity exists in the RRP and TGA, the Fed doesn’t need to make dramatic policy changes to acknowledge fiscal dominance.
Once the TGA is depleted (a positive for dollar liquidity) and subsequently replenished due to hitting and raising the debt ceiling (a negative for dollar liquidity), the Fed will run out of stopgap measures to prevent an unstoppable rise in yields following its September 2024 decision to start easing. While this doesn’t impact Q1 dollar liquidity, it foreshadows potential Fed policy changes later in the year.
The chart contrasting the FFR upper bound (RHS, white, inverted) with the 10-year U.S. Treasury yield (LHS, yellow) clearly shows that bond yields have risen as the Fed lowered rates despite inflation staying above its 2% target.
The real question is how quickly the RRP balance will drop from around $237 billion to zero. I expect this to happen in Q1 as money market funds (MMFs) maximize yields by withdrawing funds and purchasing high-yielding Treasury bills. This represents a $237 billion injection of dollar liquidity in Q1.
