How will the Fed's balance sheet reduction, which will begin as early as May, affect Bitcoin?

The minutes of the Fed meeting hinted that the policy combination of "raising interest rates by 50BP + starting to shrink the balance sheet" may be implemented in May. With the simultaneous implementation of interest rate hikes and balance sheet shrinkage, the US monetary policy will enter an era of "tightening both quantity and price".

Last night and this morning, the minutes of the Federal Reserve's March monetary policy meeting showed that in the face of continued high inflation, Fed officials believe that there may be several 50 basis point rate hikes in the next regular meeting, and may begin to reduce the balance sheet by up to US$95 billion per month (US$60 billion in Treasury bonds + US$35 billion in MBS) as early as May.

The minutes showed that Federal Reserve officials discussed the balance sheet reduction roadmap at the monetary policy meeting on March 15-16, believing that reducing the balance sheet would play an important role in firming the monetary policy stance against the backdrop of raising interest rates to combat inflation, and expected that it would be appropriate to start this process at the upcoming meeting, possibly as early as May.

Fed officials generally believe that risk management will be very important in determining the appropriate stance of monetary policy, and that policy also needs to remain flexible in responding to new data and changing prospects. With inflation soaring and the labor market tight, Fed officials expect this round of balance sheet reduction to be faster than during 2017 to 2019, when the Fed's maximum monthly reduction was $50 billion.

Fed officials generally agreed to set a monthly cap of $60 billion in U.S. Treasury bonds and $35 billion in mortgage-backed securities, and believed that the maximum reduction of $95 billion per month was appropriate. Officials also said that if market conditions require, the reduction limit can be gradually implemented over three months or slightly longer.

In addition to discussions about reducing the balance sheet, officials also discussed the roadmap for future rate hikes, and they tended to take more aggressive measures. The minutes mentioned that if it were not for the conflict in Ukraine, many Fed members might have called for a 50 basis point rate hike in March.

The minutes noted that many participants noted that it might be appropriate to raise the target range by one or more 50 basis points at future meetings, particularly if inflation pressures persisted or intensified.

Faced with the worst inflation in the United States in 40 years, the Federal Reserve announced on March 16 that it would raise the target range of the federal funds rate by 25 basis points to between 0.25% and 0.5%. This is the first rate hike by the Federal Reserve since December 2018, and it also marks the official end of the zero interest rate policy implemented by the Federal Reserve since March 2020 in response to the COVID-19 pandemic, and the beginning of a new round of rate hikes.

Next, according to CME's "Fed Watch": the probability of the Federal Reserve raising interest rates by 25 basis points in May is 22.9%, the probability of raising interest rates by 50 basis points is 77.1%, and the probability of raising interest rates by 75 basis points is 0%; the probability of raising interest rates by 25 basis points or 50 basis points in June is 0%, the probability of raising interest rates by 75 basis points is 14.7%, the probability of raising interest rates by 100 basis points is 57.8%, and the probability of raising interest rates by 125 basis points is 27.6%.

After the release of the minutes, Chris Zaccarelli, chief investment analyst at Independent Advisors Alliance, said: The $95 billion monthly reduction target is a "good start", but the Fed may need to cut spending at a faster pace to fight inflation. At the current rate, it may take more than five years (or even up to eight years) to liquidate all securities held. Before this happens, we are likely to encounter a recession, which may force the Fed to increase its balance sheet again, so market distortions may continue for a long time.

In the last balance sheet reduction cycle, the cryptocurrency market experienced some twists and turns. In the fourth quarter of 2018, when the scale of monthly balance sheet reduction reached its peak, Bitcoin experienced a large decline. At that time, Powell commented that interest rates were "a long way from neutral", which triggered more panic and a wave of selling in US stocks, which in turn led to a decline in Bitcoin.

How will this round of interest rate hikes and balance sheet reductions affect the crypto market? Galaxy Digital CEO Novogratz said in a conversation with BTC advocate and investor Anthony "Pomp" Pompliano at the Bitcoin 2022 conference in Miami on Wednesday that he was impressed by Bitcoin's recent performance considering macro headwinds such as the Fed's rate hikes. Novogratz said that I think Bitcoin is trading very well and believes that Federal Reserve Chairman Jerome Powell has "realized that he is behind the situation" and warned that he may be "very tough" for a while. Novogratz pointed out: "Powell wants to maintain his reputation. Once the Fed pauses its rate hikes, I think Bitcoin will skyrocket."