Why did the Fed inject $29.4 billion in liquidity and what does it mean for Bitcoin?

The US Federal Reserve (Fed) injected $29.4 billion into the banking system on Friday, sparking optimism on crypto social media. While this move is aimed at alleviating liquidity concerns and supports risky assets, including Bitcoin, it is not unusual.

The Federal Reserve has pumped billions of dollars into the largest overnight repurchase operation since the 2020 coronavirus pandemic to ease the liquidity stress that is said to be holding down Bitcoin prices. BTC$107,918.10 It has increased in recent weeks.

The operation, conducted through the Standing Repo Facility (SRF), was designed to temporarily increase cash available to primary dealers and banks, add short-term liquidity to the system, return repo rates to normal levels, prevent a sudden freeze in short-term money markets, and give banks leeway to manage their reserves while the Fed monitors the situation.

This all sounds too technical, so let’s break it down to understand how repos, bank reserves, and the Fed’s latest actions are related.

repository

A repo, or repurchase agreement, is a short-term loan made overnight between two parties. One party has idle cash in bank deposits and wants to generate yield from it, and the other party is looking for a cash loan against valuable collateral such as U.S. Treasury bills or bills.

Both parties agree on an interest rate and lend cash overnight with the promise to buy back the asset the next day. The lenders in these transactions are typically large money managers, such as money market funds.

bank reserves

Repo transactions affect banks’ reserves. When a lender transfers cash to a borrower, the lender’s bank reserves decrease, but the borrower’s bank reserves increase. Individual banks are more susceptible to strain if many of their accounts lend money to borrowers at other banks.

Banks require sufficient reserves to meet regulatory requirements and conduct day-to-day operations, so they can borrow on their own or adjust their balance sheets as needed. And if it faces a shortfall, it will use the repo market and other Fed facilities such as the discount window and supplementary financing rate (SFR).

But when reserve shortages become severe across the system, repo rates rise and liquidity tightens as there is less loanable cash and more borrowers compete for less cash.

This is the Fed’s intervention, and that’s exactly what it did on October 31st. The massive liquidity injection through the SRF, a tool introduced to provide quick financing backed by Treasury and mortgage bonds, comes as bank reserves have fallen to $2.8 trillion and repo rates have risen.

There was reportedly a shortage of loanable cash due to balance sheet drains known as quantitative tightening (QT) and the Treasury Department’s decision to increase the Fed’s checking account, known as the Treasury General Account (TGA). Both withdrew cash from the system.

Putting it all together

• Repo rates rose as the Fed’s QT and the Treasury’s cash buildup created a shortage of loanable cash.
• Bank reserves fell below the expected ample level.
• This situation caused some stress.
• This prompted the Fed to provide liquidity through the SRF Facility.

How will it affect BTC?

The $29 billion liquidity boost will effectively counter tightening by temporarily expanding bank reserves, lowering short-term interest rates and easing borrowing pressure.

This move will help avoid a potential liquidity crisis that could damage financial markets, and ultimately support risky assets like Bitcoin, which are seen as purely leveraging fiat liquidity.

That said, what the Fed did on Friday does not amount to quantitative easing (QE) involving direct Fed asset purchases, nor is it indicative of imminent quantitative easing (QE). This expands balances to increase system-wide liquidity levels over months or years.

The Fed’s actions Friday represent a reversible short-term liquidity tool, but they may not necessarily stimulate risk assets as much as quantitative easing.

Plus, as Andy Constan, CEO and CIO of Damped Spring Advisors, said about X, everything will take care of itself.

“Only if we actually suddenly run out of system-wide reserves will we need more aggressive action by the Fed. What’s happening now is some rebalancing among banks, some credit stress, and some tightening of the system to the TGA. All will be fine,” Constant said on X.

“Otherwise, interest rates will remain elevated and escalate further, and the SRF will have to grow rapidly. Before that, it is almost worth ignoring,” Constant added.