The central bank’s balance sheet declined by $88 billion to $6.97 trillion (-1.5%) in the week ending July 8, having hit a record high of $7.16 trillion in early June, according to the data source Federal Reserve Bank of St. Louis. The decline is the largest in 11 years.
The drop is a sign of the Fed starting to unwind the liquidity-boosting measures rolled out over the past four months to counter the economic effects of the coronavirus crisis. Some have anticipated a pullback in bitcoin prices as a result.
That’s because the leading cryptocurrency by market value has recently developed a relatively positive correlation with the S&P 500. And Wall Street’s equity index has rallied by over 40% since a slump in March, largely on the back of Fed’s balance sheet expansion.
As such, a contracting balance sheet could portend a pullback in stocks, and perhaps bitcoin.
However, zooming into the details of the Fed’s balance sheet reveals the reduction has been primarily driven by a drop in demand for emergency liquidity measures, a sign the coronavirus-induced stress in the financial system has eased.
“Less emergency funding being used is a healthy sign,” said Richard Rosenblum, co-founder of GSR. “Markets might not be able to stand completely on their own two feet, but they are at least a bit further from code red emergency mode.”
Notably, dollar swap lines — reciprocal agreements between central banks to keep currency available for their commercial banks — have fallen by over $40 billion, as noted by Lyn Alden, founder of Lyn Alden Investment Strategy.
The Fed opened dollar swap lines with other central banks after the coronavirus crash caused a dollar shortage in the international markets. Therefore, the latest decline in the dollar swap lines could be considered good news.
Meanwhile, the balance of outstanding repurchase agreements, or repos, slipped to zero from $61.2 billion seen in the week ended July 1. Repos are a source of short-term funding for commercial banks. The Fed began injecting liquidity in the repo market in mid-September 2019 and ramped up the effort following the market crisis in March.
As such, the decline in repos to zero indicates that the coronavirus-induced stress in the funding markets has eased significantly.
However, the Fed is still injecting liquidity into the U.S. economy via purchases of U.S. treasuries at a faster pace. The central bank accumulated treasuries worth $18 billion during the past week, pushing the overall bond holdings to a new high of $4.23 trillion.
All in all, the Fed’s balance sheet contraction and drop in repos and swap lines appear indicative of a Goldilocks scenario for equities, given the ongoing crisis at least, and seems unlikely to pose a threat to bitcoin’s price.
The cryptocurrency would still face stronger selling pressure if stocks once more collapse on adverse coronavirus news. But the market is still showing resilience with a measured drop, even though U.S. registered 65,551 new coronavirus cases on Thursday, a new daily record, according to John Hopkins University.
At press time, futures tied to the S&P 500 are reporting a 0.33% decline, while bitcoin is changing hands near $9,170, having faced rejection above $9,400 on Thursday.
Bitcoin fell below $9,150 early Friday, reversing most of the gain from $9,060 to $9,480 seen in the first half of the week.
The pullback has invalidated the bullish view put forward by Wednesday’s upside break of a falling channel represented by trendlines connecting June 1 and 22 highs and June 2 and 15 lows.
Essentially, it’s a case of failed breakout, which chart analysts consider a powerful bearish signal. In addition, the 3% decline seen in the past 24 hours has established another bearish lower high on the daily chart, as noted by popular analyst Josh Rager.
Even so, it is still too early to say the bears have regained control because the cryptocurrency is holding above $9,000. Sellers have failed multiple times in the last four weeks to establish a strong foothold below that psychological support.
As such, the immediate outlook would remain neutral as long as prices are trapped in the range of $9,000 and $9,480 (Wednesday’s high). Acceptance under $9,000 may prove costly — so much so that the cryptocurrency may end up falling to $7,100.
Meanwhile, a move above $9,480 would put the focus on the psychological hurdle of $10,000 once more. Option traders are betting on a bullish breakout.