The bull market of balance sheet reduction: the last carnival?

I searched for her among the crowd for hundreds of times. Suddenly I looked back and found her there, in the dimly lit place. ——Xin Qiji, "Qingyu'an·Lantern Festival"

This line of lyrics by Xin Qiji was exactly what Wang Guowei quoted to refer to the third level of learning.

I wandered around, stopping and looking for the fragrance among the flowers. When I looked back, I suddenly found the person I loved standing there in the dim light.

It is just like looking for a bull in the market but not finding it. When you look back by chance, you discover that the bull is lurking in the biggest bear market.

Compared with the lofty ambition of the first realm "Last night the west wind withered the green trees, I went up to the high building alone and looked at the end of the world" (2022/3/28 article "Bitcoin breaks through 45,000 US dollars"), and the unswerving determination of the second realm "My clothes are getting looser and looser, and I will never regret it, and I will become haggard for her" (2022/3/29 article "My clothes are getting looser and looser, and I will never regret it"), the "suddenly looking back" of the third realm tells the surprise of suddenly seeing the Peach Blossom Spring after repeated searches, and suddenly becoming enlightened in the most subtle places.

Many previous articles have deduced the extension of this bull market, the second half of this bull market, and whether this bull market is a bull market or a bear market so far.

There have also been speculations about Ethereum’s big merger and switch to PoS, but it is ultimately not up to the task.

History will continue to prove that only Bitcoin has the ability to launch a bull market. The second half is no exception.

Only by reviewing all the articles, notes, and experiences since the end of 2020 can we get a glimpse of the clues.

After all, we are too focused on running forward, but often forget the experience of going through thousands of sails.

Thousands of ships pass by the sunken boat, and thousands of trees bloom in front of the dead tree.

The Federal Reserve's monetary policy has shifted from massive QE, and will begin raising interest rates in November 2021. The trend of monetary easing to tightening is like a rolling stone downhill, unstoppable, and it will not stop until the goal is achieved.

Before the turn begins, the decision may be hesitant. But once the decision is made and the action begins, it will only increase the stakes and never give up easily until the goal is achieved. To imagine that the Fed will change is to look down on it.

They said they would taper in November, so they did. They said they would accelerate taper, so they did it in March. They said they would raise interest rates early, so they started raising interest rates in March. The Fed keeps its word and keeps its promise.

The yellow crane has gone away and will never return, and the white clouds float in the sky for thousands of years.

Now, it is highly likely that interest rates will continue to rise, and even that the balance sheet reduction will begin ahead of schedule, the so-called quantitative tightening (QT).

RBC Global Asset Management wrote a great report in January about the Fed’s quantitative tightening and its impact. Excerpt from the report:

“The Federal Reserve’s (Fed) balance sheet is nearly $9 trillion, equivalent to 36% of U.S. GDP. The Fed’s monetary policy committee, the FOMC, has indicated that it will soon begin “balance sheet normalization,” starting with the end of large-scale asset purchases (quantitative easing or “QE”) in March, and then reducing the size of the balance sheet.

“This paper explores uncertainty about the path of balance sheet contraction—quantitative tightening or “QT”—and the implications for monetary conditions.

“Modeled a path for the Fed’s balance sheet reduction starting in July 2022 (announced in March or May) based on monthly caps on Treasury and MBS redemptions of $60 billion and $30 billion, respectively. Relative to pre-pandemic size of 17%, the balance sheet would shrink by $775 billion in 2022 (including maturing Treasury bills), $1 trillion in 2023, and $840 billion in 2024, or about 22% of GDP.

“The implied size of the balance sheet reduction in 2022 is $775 billion (including Treasuries), equivalent to an increase in the federal funds rate of about 20 basis points in 2022 (or about 10 basis points if Treasuries are excluded) and a cumulative increase in the federal funds rate of 80 basis points over the period to the end of 2024. The Fed paused its quarterly rate hike cycle in September 2017 when it announced the start of QT.

“In the near term, a key source of uncertainty is what the Fed will do with its $326 billion portfolio of Treasury bills (90% of which has a maturity of 6 months or less)—it could start using them to initiate balance sheet reduction earlier than QT or set a separate cap on its run-off.

“Given that the Fed’s record purchases of Treasury Inflation-Protected Securities (TIPS) have resulted in negative real yields, a reduction in the Fed’s TIPS holdings could lead to a sharp rise in real yields, which is typically associated with a stronger dollar and challenges valuations for riskier and longer-term growth assets.

“The Fed is unlikely to formally specify the ultimate or ‘normalized’ size of its balance sheet – that will depend on the level of bank reserves the Fed maintains consistent with effective monetary operations (when bank reserves fell below $1.5 trillion in 2019, money market rates spiked, prompting the Fed to buy Treasury bills).”

Everyone knows that monetary tightening is bad for financial markets. However, the market always anticipates people's predictions and then reacts in ways that are hard to fathom.

Learn from history. On September 19-20, 2017, the Federal Reserve FOMC held a meeting. After the meeting, it was announced that it decided to start shrinking the balance sheet in October.

Half a month before the meeting, on September 1, Bitcoin reached a local high of $4,900, approaching $5,000. It then fell all the way. On the 15th, it tested the support level of $3,000 (the lowest was $2,970) and then rebounded.

On the 18th, the day before the meeting on the 19th and 20th, speculators rushed in and the price surged to over $4,000. After the meeting, after several days of correction, it fell back to $3,500 on the 22nd.

In addition, there were two major negative factors in September. One was the “94-article” clearance of exchanges, and the other was the Fed’s determination to shrink its balance sheet. Under the heavy hammer of the two major negative factors, the 22nd withstood the 3,500 dollars.

Everyone knows the story after that. Bitcoin kept going wild. One month later, on October 22, it broke through $6,000. In early November, it broke through $7,000. On November 12, it fell back to $6,000 to confirm new support. On November 22, it broke through $8,000. In early December, it broke through $16,000. On December 10, it fell back to test the new support of $13,000. On December 17, it broke through $19,000 and reached the peak of this round of bull market (the data recorded by different exchanges for the highest point are slightly different, ranging from $19,000 to $19,800).

The second half lasted less than 2 months.

Why is there a balance sheet reduction bull market?

From the perspective of psychological game, institutions or dealers who are serious about hoarding coins are seeing the implementation of balance sheet reduction and the approaching cold winter. Although they still want to continue to suppress the market and absorb more low-priced chips, the situation does not wait for anyone. If they do not pull up the market to distribute shipments at high levels and stock up enough food and grass for the winter, I am afraid that as the monetary tightening effect gradually consolidates and asset bubbles are depleted, the chips that they have worked hard to hoard for more than half a year will rot in their hands, and they will have to endure the winter and wait for the next bull market.

This is the game-theoretic inevitability of the second half.

Of course, the external situation also needs to be able to fulfill this wish.

How high will the position go? I have actually already written about this question in my article "Three Predictions" on December 20, 2020. I will not repeat it here. Readers can also refer to the review of the second half of 2017 and make their own inferences based on the multiples and psychological satisfaction.

As for the time, we only know roughly that according to the schedule of the Federal Reserve's 2022 FOMC interest rate meeting, it will be held on May 3rd and 4th.

Two months after May is July.

Don’t worry about the deviation of one or two months. Considering the 140-year growth period of Bitcoin (2009-2140), this deviation is really not worth mentioning.

Just like today's fluctuation of a few thousand dollars is insignificant compared to the future million-dollar pie.

The above is just a mental exercise. It is for academic discussion only. It does not constitute any investment advice. Do not blindly believe it.