Just as the markets may have settled the long-running US debt limit drama, those holding risky assets such as cryptocurrencies could face a new challenge. The US Treasury is expected to spend up to $1 trillion on cash reserves to replenish its depleted balance.
“The impending reserve drawdown, due to the Treasury General Account rebuild, may prove to be a headwind,” reported Citi Research. They conducted an analysis of the performance of risky assets during such drawdowns and found that they are vulnerable to increased volatility and lower returns. Therefore, the near-term outlook for Bitcoin and Ether doesn’t seem too positive.
The Treasury General Account, which stores money for the Treasury, ballooned during the pandemic and has now reached its lowest level ever. As a result, the Treasury needs to replenish the cash reserve to meet its obligations via bill sales, estimated to reach over $1 trillion by the end of the third quarter. This supply burst may drain liquidity from banks and increase short-term financing rates in a potentially recession-bound economy.
This does not bode well for digital-asset investors who had just recovered from the fears of a no-deal scenario for the US debt ceiling. Bitcoin is higher today, but is still hovering around the $27,000 mark, which it has failed to break away from for weeks.
“Crypto markets were not immune to fears of the US defaulting on its debt, selling off on negative developments and rallying on headlines suggesting progress,” wrote the strategists. They noted that Bitcoin performed well during a period of banking turmoil. However, the US Government is an institution that could be at risk, which “doesn’t paint a favorable outlook for decentralized digital assets.”
The strategists used the Cboe Volatility Index, an indicator of the market’s fear, to gauge whether a resolution would be passed before the debt ceiling was reached. Whenever equity market concerns were eased, Bitcoin outperformed.
On Friday, the US Senate passed legislation suspending the debt ceiling until the 2024 election. The measure now goes to President Joe Biden for signing, just a few days before the looming US default.
Year-to-date, Bitcoin has recovered by about 60%, after its second-worst year in history in 2020 with a 64% drop. Its current support hovers around $26,500, according to Fiona Cincotta, Senior Market Analyst at City Index. A drop below $25,000 may signal a more significant sell-off.
“The problem is the macro backdrop, which is relatively uncertain going forward with recessionary fears,” Cincotta said. “What will make Bitcoin shine is a nice dovish pivot from the Federal Reserve. That might be the tide that sees another decent leg higher.”
Bitcoin’s defining characteristic of late has been its ‘bound trade’ with its 30-day volatility remaining low at 1.8%, firmly within its two-month-long trading range. Despite growing short-term volatility, options implied volatility trended lower over the past week. However, Bitcoin Exchange-traded commodities continued to see steady withdrawals and spot and futures volumes are trending lower.