The Federal Reserve Intervenes: Bank Term Funding Program

The Federal Reserve balance sheet increased by $300 billion in one week, leading to debate about whether these actions qualify as quantitative easing.

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The Lender Of Last Resort

Just days after the fallout from Silicon Valley Bank and the establishment of the Bank Term Funding Program (BTFP), there’s been a significant rise in the Federal Reserve’s balance sheet after a full year of decline via quantitative tightening (QT). The PTSD from extensive quantitative easing (QE) is causing many people to sound the alarms, but the changes in the Fed’s balance sheet are a lot more nuanced than a new regime shift in monetary policy. In absolute terms, it’s the largest increase in the balance sheet we’ve seen since March 2020 and in relative terms, it’s an outlier that’s catching everyone’s attention. 

Weekly change in the Fed’s balance sheet

The key takeaway is that this is much different than the QE spree of asset buying and the stimulative easy money with near-zero interest rates that we’ve experienced over the last decade. This is about select banks needing liquidity in times of economic distress and those banks getting short-term loans with the goal of covering deposits and paying the loans back in quick fashion. It’s not the outright purchase of securities to indefinitely hold on the balance sheet from the Fed, but rather balance sheet assets that should be short-lived while continuing QT policy.

Nonetheless, it is a balance sheet expansion and a liquidity increase in the short-term — potentially just a “temporary” measure (still to be determined). At the very least, these liquidity injections help institutions not become forced sellers of securities when they otherwise would be. Whether that’s QE, pseudo QE, or not QE is besides the point. The system is showing fragility once again and the government has to step in to keep it from facing a systemic risk. In the short-term, assets that thrive on liquidity increase, like bitcoin and the Nasdaq which have ripped higher at the exact same time.

This specific increase of the Fed’s balance sheet is due to a rise in short-term loans across the Fed’s discount window, loans to FDIC bridge banks for Silicon Valley Bank and Signature Bank and the Bank Term Funding Program. Discount window loans were $152.8 billion, FDIC bridge bank loans were $142.8 billion and BTFP loans were $11.9 billion for a total of over $300 billion. 

Source: Federal Reserve Statistical Release 

The more alarming increase is in the discount window lending as that is a last resort, high cost liquidity option for banks to cover deposits. It was the largest discount window borrowing on record. Banks using the window are kept anonymous as there is a legitimate stigma issue from finding out who’s in need of short-term liquidity. 

Source: WSJ, Federal Reserve 

This brings back recent memories of the 2019 emergency liquidity injection and intervention by the Fed into the repo market to stabilize cash demand and short-term lending activities. The repo market is a key overnight financing method between banks and other institutions.

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The Upcoming FOMC Meeting

The market is still expecting a 25 bps rate hike at the FOMC meeting next week. All-in-all, the market turmoil so far hasn’t proven to “break enough things” yet, which would require an emergency pivot from central bankers.

On its path to bringing inflation back to the 2% target, month-over-month Core CPI was still increasing in February while initial jobless claims and unemployment haven’t budged much. Wage growth, especially in the services sector, still remains fairly strong at the 3-month annualized rate of 6% growth last month. Although slightly coming down, more unemployment is where we will have to see more weakness in the labor market in order to take wage growth much lower. 

Source: Federal Reserve Bank of Atlanta

We’re likely far from the end of the chaos and volatility this year,as each month has brought new levels of uncertainty in the market. This was the first sign of the system needing Federal Reserve intervention and swift action. It likely won’t be the last in 2023.

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Bitcoin’s Correlation To Risk Assets

While many bitcoin investors look for the asset to behave as a safe haven, bitcoin typically has ultimately acted as the riskiest of all risk allocations.

The below is an excerpt from a recent edition of Bitcoin Magazine PRO, Bitcoin Magazine’s premium markets newsletter. To be among the first to receive these insights and other on-chain bitcoin market analysis straight to your inbox, subscribe now.

Short-Term Price Versus Long-Term Thesis

How bitcoin, the asset, will behave in the future versus how it currently trades in the market have proven to be drastically different from our long-term thesis. In this piece, we’re taking a deeper look into those risk-on correlations, and comparing the returns and correlations across bitcoin and other asset classes.

Consistently, tracking and analyzing these correlations can give us a better understanding if and when bitcoin has a real decoupling moment from its current trend. We don’t believe we are in that period today, but expect that decoupling to be more likely over the next five years.

Macro Drives Correlations

For starters, we’re looking at the correlations of one-day returns for bitcoin and many other assets. Ultimately we want to know how bitcoin moves relative to other major asset classes. There’s a lot of narratives on what bitcoin is and what it could be, but that’s different from how the market trades it.

Correlations range from negative one to one and indicate how strong of a relationship there is between two variables, or asset returns in our case. Typically, a strong correlation is above 0.75 and a moderate correlation is above 0.5. Higher correlations show that assets are moving in the same direction with the opposite being true for negative or inverse correlations. Correlations of 0 indicate a neutral position or no real relationship. Looking at longer windows of time gives a better indication on the strength of a relationship because this removes short-term, volatile changes.

What’s been the most watched correlation with bitcoin over the last two years is its correlation with “risk-on” assets. Comparing bitcoin to traditional asset classes and indexes over the last year or 252 trading days, bitcoin is most correlated with many benchmarks of risk: S&P 500 Index, Russel 2000 (small cap stocks), QQQ ETF, HYG High Yield Corporate Bond ETF and the FANG Index (high-growth tech). In fact, many of these indexes have a strong correlation to each other and goes to show just how strongly correlated all assets are in this current macroeconomic regime.

The table below compare bitcoin to some key asset-class benchmarks across high beta, equities, oil and bonds. 

Note, you can find any of these indexes/assets on Google Finance with the tickers above. For 60/40, we’re using BIGPX Blackrock 60/40 Target Allocation Fund, GSG is the S&P GSCI Commodity ETF, and BSV is the Vanguard Short-Term Bond Index Fund ETF. 

Another important note is that spot bitcoin trades in a 24/7 market while these other assets and indexes do not. Correlations are likely understated here as bitcoin has proven to lead broader risk-on or liquidity market moves in the past because bitcoin can be traded at any time. As bitcoin’s CME futures market has grown, using this futures data produces a less volatile view of correlation changes over time as it trades within the same time limitations as traditional assets.

Looking at the rolling 3-month correlations of bitcoin CME futures versus a few of the risk-on indexes mentioned above, they all track nearly the same. 

Bitcoin CME futures correlated with risk-on assets.

Although bitcoin has had its own, industry-wide capitulation and deleveraging event that rival many historical bottoming events we’ve seen in the past, these relationships to traditional risk haven’t changed much.

Bitcoin has ultimately acted as the riskiest of all risk allocations and as a liquidity sponge, performing well at any hints of expanding liquidity coming back into the market. It reverses with the slightest sign of rising equities volatility in this current market regime.

We do expect this dynamic to substantially change over time as the understanding and adoption of Bitcoin accelerates. This adoption is what we view as the asymmetric upside to how bitcoin trades today versus how it will trade 5-10 years from now. Until then, bitcoin’s risk-on correlations remain the dominant market force in the short-term and are key to understanding its potential trajectory over the next few months.

Read the full article here.

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