Arthur Hayes: When will this market peak? What trading strategies should be adopted?

The backcountry terrain of Hokkaido ski resorts is excellent, and most of it is accessible by cable car. At the beginning of the ski season, the biggest concern is when there will be enough snow to open the ski resorts. The problem for skiers is that the bamboo forests are full of bamboo. Bamboo stems are thin and reed-like, but have sharp green leaves that can cut your skin if you are not careful. Trying to ski in the bamboo forest is dangerous because your blade may slip, leaving you in a game I call "man vs. tree". Therefore, if the snow is not enough to cover the bamboo forest, the backcountry is extremely dangerous.

Hokkaido has seen the most snowfall in nearly seven decades. The snow is very thick. As a result, the gates to remote areas are opening in late December, not the first or second week of January. As 2025 approaches, the question on the minds of cryptocurrency investors is whether the policies Trump wants to pursue will continue . In my latest article, "Arthur Hayes: How Trump's New Deal and Countries' Response Will Affect Crypto", I argued that the high expectations for policy actions from the Trump camp have disappointed the market. I still think this is a potential negative factor that may put pressure on the market in the short term, but against this I have to balance the liquidity impulse of the US dollar. For now, Bitcoin will waver as the speed of US dollar issuance changes. Monetary officials with power in the Federal Reserve and the US Treasury determine the amount of US dollars supplied to the world's financial markets.

Bitcoin bottomed in the third quarter of 2022, when the Fed's reverse repo facility (RRP) peaked. At the behest of U.S. Treasury Secretary Bad Gurl Yellen, her department issued fewer long-term coupon bonds and more short-term zero-coupon notes, which drained more than $2 trillion from the RRP. This was a liquidity injection into global financial markets. Cryptocurrencies, especially large U.S.-listed tech stocks, fell sharply as a result. The above chart shows Bitcoin (LHS, yellow) versus RRP (RHS, white, inverted); as you can see, as RRP fell, Bitcoin rose.

The question I intend to answer is whether the positive USD liquidity impulse can curb disappointment with the pace and impact of Trump’s supposedly pro-crypto and pro-business policies through at least the first quarter of 2025. If so, then it’s safe to shred it, and Maelstrom should add risk to its book.

First, I will discuss the Federal Reserve, which is a minor consideration in my analysis. Then, I will discuss how the U.S. Treasury will respond to the debt ceiling. If politicians hesitate to raise the debt ceiling, the Treasury will cut its general account (TGA) at the Federal Reserve, injecting liquidity into the system and creating positive momentum for cryptocurrencies.

For the sake of brevity, I will not explain why the debits and credits of RRP and TGA are negative and positive respectively for USD liquidity.

Fed

The pace of the Fed’s quantitative tightening (QT) policy remains at $60 billion per month, which means that the size of its balance sheet has shrunk. There is no change in the Fed’s forward guidance on the pace of quantitative tightening. I will explain why later in the article, but my forecast is that the market will peak in mid-to-late March, so this is equivalent to a reduction of $180 billion worth of liquidity from January to March due to quantitative tightening .

The RRP has fallen to almost zero. In order to completely exhaust the tool, the Fed belatedly changed the policy rate on the RRP. At its December 18, 2024 meeting, the Fed cut the RRP rate by 0.30%, 0.05% more than the policy rate cut. This pegged the RRP rate to the lower bound of the federal funds rate (FFR).

If you are wondering why the Fed is waiting until the RRP is almost exhausted before realigning the interest rate with the FFR floor and making it less attractive to park money in this facility, I implore you to read Zoltan Pozar’s article “Cheating Cinderella”. My takeaway from his article is that the Fed is using every trick in the book to stimulate demand for Treasury issuance before resorting to stopping QT, again providing supplementary leverage ratio exemptions for US commercial bank branches, and possibly resuming quantitative easing (QE), aka “starting the printing presses.”

Currently, there are two pools of funds that will help control bond yields. For the Fed, the 10-year Treasury yield cannot exceed 5% because this is the level at which bond market volatility explodes (MOVE index). As long as there is liquidity in the RRP and TGA, the Fed does not have to drastically change its monetary policy and acknowledge fiscal dominance.

Once the TGA is exhausted (USD liquidity is positive) and subsequently replenished by the debt ceiling being hit and subsequently raised (USD liquidity is negative), the Fed will no longer have stopgap measures to stop the inexorable rise in yields following its decision to start an easing cycle last September. This is not important for USD liquidity conditions in the first quarter, but only for a possible change in Fed policy later this year if yields continue to rise.

A comparison of the FFR cap (RHS, white, inverted) with the US 10-year yield (LHS, yellow) clearly shows that bond yields have risen as the Fed has cut rates amid inflation above its 2% target.

The real question is how quickly RRP falls from about $237 billion to zero. I expect it to reach near zero sometime in the first quarter as money market funds (MMFs) maximize their yields by withdrawing funds and buying higher yielding T-bills. To be very clear, this represents a $237 billion injection of USD liquidity in the first quarter.

After the RRP rate adjustment on December 18, the yield on Treasury bills with maturities of less than 12 months was above 4.25% (white), which is the FFR floor.

The Fed will withdraw $180 billion in liquidity as a result of quantitative tightening and encourage an additional $237 billion in liquidity as RRP balances decrease as a result of the Fed adjusting its reward rate. This totals a net injection of $57 billion in liquidity.

Ministry of Finance

Yellen told the market that she expects the Treasury to begin taking "extraordinary measures" to fund the U.S. government between January 14 and 23. The Treasury has two options on how to pay the government's bills. They can issue debt (negative USD liquidity) or spend funds from their checking account at the Fed (positive USD liquidity). Since the total debt cannot be increased until the U.S. Congress raises the debt ceiling, the Treasury can only spend funds from its checking account, the TGA. Currently, the TGA balance is $722 billion.

The first big if is when politicians will agree to raise the debt ceiling. This will be the first test of how strong Trump's support is among Republican lawmakers. Remember, his governing advantage - that is, Republican majorities over Democrats in the House and Senate - is very thin. There is a faction of the Republican Party that likes to puff up their chests and strut around, claiming that they care about reducing the size of bloated government every time the debt ceiling is discussed. They will insist on voting for an increase in the debt ceiling until they deliver a big reward for their constituencies. Trump can no longer convince them to veto a spending bill at the end of 2024 unless the debt ceiling is raised. Democrats, after getting beaten up in gender-neutral bathrooms in the last election, will no longer be willing to help Trump free up government funds to achieve his policy goals. Harris 2028, anyone? In fact, the Democratic presidential candidate will be the silver fox Gavin Newsom. So to get the job done, Trump would be wise to exclude the debt ceiling issue from any proposed legislation unless it is absolutely necessary.

Raising the debt ceiling becomes necessary when failure to do so would result in a technical default on maturing Treasury bonds or a complete government shutdown. Based on the 2024 revenue and expenditure data released by the Treasury Department, I estimate that this will happen between May and June of this year, when the TGA balance will be completely depleted.

It is helpful to visualize the speed and intensity with which the TGA is used to fund the government and predict when drawdowns will have the greatest impact. Markets are forward-looking. Given that this is public data and we know how it works when the Treasury cannot add to the total US debt as the account nears depletion, markets will look for new sources for USD liquidity. At 76% depletion, March seems like the time when markets will ask “what’s next?”

If we add up the amount of U.S. dollar liquidity held by the Federal Reserve and the Treasury as of the end of the first quarter, the total is $612 billion.

What happens next?

Once default and shutdown are imminent, a last minute deal is reached and the debt ceiling is raised. At that point, the Treasury will be free to borrow on net again and the TGA will have to be refilled. This will be negative for USD liquidity.

Another important date in the second quarter is April 15, when taxes are due. As can be seen in the table above, the government's fiscal position improved significantly in April, which is a negative for USD liquidity.

If factors affecting TGA balances were the only factors determining cryptocurrency prices, I would expect a market top to occur at the end of Q1. In 2024, Bitcoin hit a local high of around $73,000 in mid-March before moving sideways and beginning a multi-month decline just before the 15th tax deadline on April 11.

Trading strategies

The problem with this analysis is that it assumes that USD liquidity is the most important marginal driver of global fiat liquidity. Here are some other considerations:

- Will China speed up or slow down its creation of RMB credit?

- Will the Bank of Japan start raising its policy rate, thereby allowing USD/JPY to appreciate and unwind leveraged carry trades?

- Will Trump and Bessant significantly devalue the dollar against gold or other major fiat currencies overnight?

- How effective will the Trump team be at cutting government spending and passing legislation quickly?

None of these major macroeconomic issues can be known in advance, but I have confidence in the math behind how RRP and TGA balances will change over time. My confidence has been further reinforced by market performance from September 2022 to date: despite the Fed and other central banks raising rates at the fastest pace since the 1980s, the increase in USD liquidity due to falling RRP balances has directly led to higher cryptocurrency and stock prices.

FFR cap (right, green) vs Bitcoin (right, magenta) vs S&P 500 (right, yellow) vs RRP (left, white, inverted). Bitcoin and stocks bottomed in September 2022 and rallied as the RRP fell, injecting over $2 trillion of liquidity into global markets. This was a deliberate policy choice by bad girl Yellen, issuing more Treasuries to drain the RRP. Powell and his campaign to tighten financial conditions to fight inflation have completely failed.

With all these caveats in mind, I believe I have answered the question I posed at the outset. That is, the disappointment of the Trump team with its proposed pro-crypto and pro-business legislation can be offset by an extremely positive USD liquidity environment, which increased by a whopping $612 billion in Q1. As happens almost every year, late in Q1 was the time to sell, relax at the beach, at the counter, or at a ski resort in the Southern Hemisphere, and wait for positive fiat liquidity conditions to re-emerge in Q3.

As Maelstrom’s CIO, I will encourage risk takers in the fund to move risk into DEGEN (Degen is short for Degenerate, and is often used to refer to people who engage in high-risk speculative trading or investing in cryptocurrencies). The first step in this direction was our decision to enter the burgeoning decentralized science token space. We like undervalued tokens and have bought $BIO; $VITA; $ATH; $GROW; $PSY; $CRYO; $NEURON. For a deeper dive into why Maelstrom believes the DeSci narrative is ripe for a re-rating, read “Degen DeSci”. If things play out to high levels as I have described, I will cut the baseline and ride the 909 open hi-hat sometime in March. Of course, anything can happen, but overall, I am optimistic. Have I changed my mind from my last article? Somewhat. Maybe the Trump sell-off happened in mid-December to the end of 2024 instead of mid-January 2025. Does this mean I am sometimes a poor predictor of the future? Yes, but at least I absorb new information and perspectives and change them before they lead to big losses or missed opportunities. That's why this investing game is intellectually appealing. Imagine if you could get a hole-in-one every time you play golf, hit every three-point shot when playing basketball or resting, and sink every ball in pool. Life would be very boring. Whatever, let me fail and succeed and be happy. But hopefully a little more success than failure.