Here’s Why Bitcoin’s Price May Correct After the US Government Resolves the Debt Limit Standoff


For much of 2022, the crypto market has been focused on US Federal Reserve stocks. The central bank has created a bearish environment for risky assets like stocks and cryptocurrencies by raising interest rates on borrowings.

Towards the end of 2022, positive economic data, healthy employment numbers and a falling inflation rate raised hopes that a long-awaited slowdown in the rate of interest rate hikes would occur. Currently, the market expects rate hikes will reduce from 50 basis points (bps) to 25 bps before the complete end of the bullish regime by mid-2023.

From the perspective of the Fed’s goal of limiting liquidity and providing headwinds to an overheated economy and stock market, things are starting to look up. It looks like the Fed’s plan for a soft landing through quantitative tightening to rein in inflation without plunging the economy into a deep recession might work. The recent rally in stock markets and Bitcoin can be attributed to market confidence in the above narrative.

However, another key US agency, the US Treasury, poses significant risks to the global economy. As the Fed drained liquidity from the markets, the Treasury provided a countermeasure by draining its cash balance and reversing some of the Fed’s efforts. This situation may be coming to an end.

He cites risks of tight liquidity conditions with the possibility of an adverse economic shock. For this reason, analysts warn that the second half of 2023 could see excessive volatility.

Disguised liquidity injections undo the Fed’s quantitative tightening

The Fed began its quantitative tightening in April by raising interest rates on its borrowings. The objective was to reduce inflation by limiting market liquidity. Its balance sheet has shrunk by $476 billion during this period, which is a positive sign given that inflation has fallen and employment levels have remained healthy.

US Fed balance sheet. Source: US Federal Reserve

However, during the same period, the US Treasury used its Treasury General Account (TGA) to inject liquidity into the market. Typically, the Treasury would sell bonds to raise additional cash to meet its obligations. However, as the country’s debt was close to its debt ceiling, the Federal Ministry used its cash to finance the deficit.

U.S. Treasury General Account Balance. Source: MacroMicro

In fact, it is a backdoor cash injection. The TGA is a net liability on the Fed’s balance sheet. The Treasury had drained $542 million from its TGA account since April 2022, when the Fed began raising rates. Freelance macro market analyst Lyn Alden told Cointelegraph:

“The US Treasury is reducing its cash balance to avoid going over the debt ceiling, adding liquidity to the system. Thus, the Treasury has offset part of the QT that the Fed makes. Once the debt ceiling issue is resolved, the Treasury will replenish its cash account, which will remove liquidity from the system.

Debt ceiling problem and potential economic fallout

US Treasury debt stood at around $31.45 trillion as of January 23. The number represents the total outstanding US government stock accumulated over the nation’s history. It is crucial because it has reached the Treasury debt ceiling.

The debt ceiling is an arbitrary number set by the US government that limits the amount of Treasury bonds sold to the Federal Reserve. Hitting it means the government can’t take on any more debt.

Currently, the United States must pay interest on its $31.4 trillion national debt and spend on the welfare and development of the country. These expenditures include the salaries of public doctors, educational institutions and pension recipients.

Needless to say, the US government spends more than it earns. Thus, if he cannot increase the debt, there will have to be a reduction in interest rate payments or government spending. The first scenario means a default in US government bonds, which opens a big Pandora’s box, starting with a loss of confidence in the world’s largest economy. The second scenario presents uncertain but real risks because non-compliance with the payment of public goods can induce political instability in the country.

But the line is not set in stone; the US Congress votes on the debt ceiling and has changed it several times. The US Treasury Department Remarks that “since 1960, Congress has acted 78 times to permanently increase, temporarily extend, or revise the definition of the debt limit – 49 times under Republican presidents and 29 times under Democratic presidents.”

If history is any indication, lawmakers are more likely to address these issues by raising the debt ceiling before any real damage is done. However, in this case, the Treasury would be inclined to increase its TGA balance again; the department’s target is $700 billion by the end of 2023.

Either by completely draining its cash by June or with the help of a debt ceiling amendment, the backdoor cash injections into the economy would come to an end. It threatens to create a difficult situation for risky assets.

Bitcoin’s Correlation to Stock Markets Remains Strong

Bitcoin’s correlation with US stock indices, particularly the Nasdaq 100, remains near all-time highs. Alden noted that the collapse of FTX suppressed the crypto market in Q4 2022 when stocks rallied on slower rate hike expectations. And while Congress delays its decision on the debt ceiling, favorable liquidity conditions have allowed the price of Bitcoin to climb.

BTC/USD price chart with Bitcoin-Nasdaq correlation coefficient. Source: Trading View

However, the correlation with the stock markets is still strong, and movements in the S&P 500 and Nasdaq 100 will likely continue to influence Bitcoin price. Nik Bhatia, finance researcher, wrote on the importance of stock market direction for Bitcoin. He said,

“…in the short term, market prices can be very wrong. But in the longer term, we need to take trends and trend reversals seriously. »

With the risks of Fed quantitative tightening underway and the cessation of Treasury liquidity injections, markets are expected to remain vulnerable throughout the second half of 2023.