Liquidity Holes create bear traps for speculative Equities and Bitcoin


PUNE ( — The transition of policy outlook from expansionary to restrictive gives rise to “liquidity holes”.

Holes are temporary phases where a higher supply of assets (such as bonds, equities, Bitcoin (BTC), etc.) meets a sunken demand. While the phenomenon emerges as a buying opportunity for the investors, it also helps reverse the downward price spiral with newfound demand, if the stricter regime works as expected.

Fuelled by a prolonged tenure of loose fiscal policies, markets have grown in experience dealing with liquidity traps. Defined as economic situations where monetary policy becomes ineffective due to very low interest rates combined with a consumer preference of saving over investments. Coming out of the trap requires a stricter monetary regime, and hence gives way to liquidity holes.

“This gap usually starts in bond markets, and eventually spreads to other risk assets like equities and cryptocurrencies,” noted Greg Jensen, co-chief investment officer at Bridgewater hedge fund.

Bitcoin trading volume. Source: Bitcoinity
Bitcoin trading volume. Source: Bitcoinity

At the base of the latest spike in Bitcoin trading volumes is the U.S. Federal Reserve’s outlook to deliver the first rate-hike only by March 2022. Moreover, the Fed also issued a weighty document pledging to shrink its balance sheet, thereafter, too.

A $350B Hole brewing in the government bonds:

Oxford Economics stated that ‘even an effective reduction of $90B stimuli a month would only contribute to a trillion-dollar offset by 2023’, making the tapering efforts look small. However, an over-supply of government bonds issued in order to sustain the high debt creates a hole in the treasury bonds segment.

JPMorgan calculated that the net supply of government bonds “that will need to be absorbed by the market will increase to $350bn” in the second half of this year. That is a big hole that could be pivotal to the execution of the latest measures by the Federal Open Market Committee.

Capital flight on the cards

In the last couple of years, a decline in U.S. equity prices has gone hand in hand with rising bond prices. This suggests that investors have responded to shocks by rotating their money between asset classes, not withdrawing it altogether.

But since the start of 2022, bond and equity prices have declined in tandem.

An even more dramatic rout surfaced in speculative asset classes, such as Cryptocurrencies. The attached chart demonstrates a stark departure of investor trust from equities and Bitcoin (BTC) to safer avenues like Gold and treasury bonds.

However, the sheer lack of juice amongst any of the assets might lead to an overall capital flight, where investors prefer derisking their portfolio from the ailing financial system.  

BTC/USD 30-min price chart. Source: Tradingview
BTC/USD 30-min price chart. Source: Tradingview

Price headwinds for Bitcoin to continue

While the latest FED stance on interest rates has rippled shivers across speculative assets, the market is starting to price in more such hikes this year. The hawkish outlook risks the trap, these liquidity holes bring along, with every tightening move. 

What could result in an exemplary model of taming inflation and resurrecting the sunken asset classes like the digital currencies and equities this time, could also turn into a deeper economic glut, rendering the very monetary policy irrelevant.

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