With the crypto market cap already down $1T for the year, digital asset holders are hoping for the bear market’s worst damage to be completed.
However, they may be out of luck, as the US Federal Reserve begins quantitative tightening (QT) on June 1, according to a report pers conference by the central bank.
QT is a monetary policy tool that the Fed uses to reduce the amount of liquidity in the economy by allowing securities on its balance sheet to reach their maturity date. These securities are primarily Treasury bonds, whose debt is serviced by the US government, and mortgage-backed securities.
The first tranche of debt will not mature until June 15, according to Alfonso Peccatiello, the former head of fixed-income portfolio management at ING Deutschland, so the true QT effect has yet to hit the US economy. Furthermore, the rate of balance sheet reduction will double from $47.5 billion for the next three months, to $95 billion in September.
Reshaping the Market
QT reversed the quantitative easing (QE) program that had reshaped markets by flooding the economy with cash and Fed support, first during the global financial crises of 2008 and 2009, and then again during the Covid-19 pandemic in 2020 and 2021.
The program boosts the Fed’s balance sheet by about $4.8 trillion after the pandemic, according to a report by the Fed. That amount makes up more than half of the Fed’s total balance sheet, which reached $8.92T on June 6, according to Federal Reserve Economic Data platforms.
Since crypto price movements have been linked to amount of liquidity in the system, a further reduction in the money supply via QT will probably be a new source of pressure on token valuation. The question is by how much?
Metric Confusion Shows Signs of Potential Recovery for ETH
Economiser, a Twitter account that describes itself as “examining DeFi and crypto from an economic point of view,” suggested that the QT effect might not be so dramatic. As evidence, the Economiser refers to The Defiant to research by the Fed likened the QT program to roughly a sustained 0.5% rate hike in terms of its effect on the economy.
“I expect crypto demand from the US to ease slightly over the next 12 months, but I don’t think demand will drop in a big way,” the Economiser told The Defiant. Economists also say they believe that BTC and ETH will not be affected differently by QT.
Rising Cost of Debt
The Economiser adds that there is reason to be concerned with regards to crypto demand in emerging markets. “Many emerging markets are borrowing significant amounts in 2020 and 2021 to fund the pandemic response,” the economist said. “Now with interest rates rising, the cost of servicing debt has increased substantially.” Economiser adds that Sri Lanka has already defaulted on their debt in May.
Others in the investment field are not so optimistic about QT. Ana Andrianova, former investment banker and founder of Akropolis, a product that aims to provide simple access to the DeFi protocol that produces results, thinks QT can play a role in propelling the world into a serious economic hub.
Retail Capital Inflow
“The upcoming recession will no doubt be unlike anything we’ve seen before,” Andrianova told The Defiant. “QT and very real hyperinflation will deprive retail investors of freedom [cash] which fueled many of the 2020-2021 bull runs.”
Founder banker-turned-DeFi adds that crypto is significantly more sensitive to retail capital inflows than more traditional markets.
QT effects have not been seen. Of course, market expectations have taken this information into account. The bears think we haven’t been hit. And of course, QT isn’t rigid either — the Fed initiated the QT . program in june 2017 though backwards earlier than expected in July 2019.
In the same way, the current QT program is equipped with an asterisk from the Fed in May announcement: “The Committee stands ready to adjust every detail of its approach to reducing the size of the balance sheet in light of economic and financial developments.”