The repo market, which is a critical piece of financial infrastructure that provides interbank liquidity, has suddenly dried up again despite the Federal Reserve injecting $500 billion this month alone as detailed in a recent Crypto.IQ article.
Basically, during the Jan. 7 repo operations, the Fed offered $35 billion of liquidity, but that was far short of the $41.12 billion of requests. Further, during the overnight repo $63.92 billion of liquidity was injected by the Fed in order to prevent the repo market from locking up.
In total, roughly $99 billion has been injected into the repo markets by the Fed in less than 24 hours, and it was not even enough to meet all of the liquidity demands.
This sudden drying up of liquidity in the repo market is unexpected. A repo crisis was expected due to the year-end turn, where banks and corporations need extra liquidity in order to pay taxes and other debts at the end of the year. The Fed bankrolled $500 billion of repo operations to handle the year-end turn, but apparently that was not enough and the repo market is continuing to lack liquidity.
This ruins the Fed’s plan of letting recent repo operations roll off of their balance sheet. Essentially, repo operations represent short term liquidity injections, and the Fed believed that after the year-end turn was over this liquidity could simply be taken out of the market via the short term liquidity injections maturing.
Indeed, the first short term repo maturations are happening this week, with $25 billion leaving the market on Jan. 6, $28.8 billion leaving on Jan. 7, and $18 billion scheduled to leave on Jan. 17.
However, the repo market freeze-up as of today, Jan. 7, proves that even a small fraction of the Fed’s $500 billion of repo injections rolling off of its balance sheet will cause a liquidity crisis. Essentially, the $500 billion of repo operations this month will have to become permanent liquidity injections rather than rolling off of the Fed’s balance sheet, scuttling the Fed’s plan for this operation to be short term.
Further, not only does the market need the liquidity injections which have already taken place to become permanent, around $100 billion of liquidity injections from the Fed will be needed every month to prevent the repo market from freezing up.
Thus, the Fed is trapped in a cycle of continuously printing and injecting vast sums of liquidity into the market in order to keep the market from crashing. If the Fed ever decides to stop injecting liquidity or to take some previously injected liquidity out of the market, an epic stock crash is pretty much guaranteed.
Ultimately, the repo market — and therefore interbank liquidity — is only functioning due to massive government money printing at this point, showing how weak the stock market and the economy truly is. Further, tensions between Iran and the United States are increasing the pressure on the economy, with stocks generally declining this past week despite the $500 billion of liquidity injections this past month.
Considering the weak state of the economy, even when hundreds of billions of dollars are being injected by the Fed, it seems possible that a serious economic event like the Strait of Hormuz being closed be a tipping point. It would likely force the stock market into a downward spiral despite the Fed’s large scale efforts to prop up the economy.
Bitcoin (BTC) stands to gain big if the repo market ultimately freezes up and stocks crash since it is being used as a safe haven asset. Indeed, in the past several days’ Bitcoin (BTC) has risen $1,000 from $6,800 to $7,800 while stocks have simultaneously weakened due to tensions between the United States and Iran.
Essentially, the rosy picture that the Fed will always be there to prop up the market is now showing cracks. The massive $500 billion injection this past month was not enough to fix the repo market, and hundreds of billions of dollars of further injections are likely needed in coming months to prevent a stock crash. And there’s a chance that no amount of injections can prevent an economic recession if things escalate with Iran.
Although this is bad news for the global economy, it could create favorable conditions for the biggest Bitcoin (BTC) rally in history, especially in combination with the upcoming May block halving.