The Federal Reserve (FED) cuts interest rates by 25 basis points trap! RRP only has 14 billion dollars left, Liquidity crisis is coming.

The Federal Reserve (FED) cut interest rates by 25 basis points, lowering the federal funds rate range to 4.0% to 4.25%, and hinted that quantitative tightening might soon come to an end. However, for Bitcoin, the near exhaustion of funds in the overnight reverse repurchase agreement (RRP) tool is more critical, with only about 14 billion dollars remaining. This shift means that even small adjustments to QT will have a huge impact on liquidity, real yields, and the dollar.

The Real Threat of RRP Exhaustion: Liquidity Structural Change

(Source: FRED)

The overnight reverse repurchase agreement (RRP) tool has only about $14 billion left, which is a critical warning signal. RRP is a short-term investment tool provided by The Federal Reserve (FED) to money market funds and other institutions that can deposit idle cash with the FED for safe returns. During the quantitative tightening process, the RRP balance acts as a liquidity buffer, and when the FED reduces its balance sheet, funds flow out of the RRP first rather than directly draining bank reserves.

However, when the RRP balance approaches zero, this buffer disappears. Any further quantitative tightening will directly consume bank reserves, which are the core source of liquidity for the functioning of the financial system. The reduction of bank reserves will increase short-term interest rates, tighten credit conditions, and may trigger liquidity pressures in the financial system.

The Federal Reserve's balance sheet is currently close to $6.6 trillion, down from a peak of $9 trillion, with total reserves around $3 trillion. Powell elaborated on this composition in a speech on October 14, describing the “final stage” of quantitative tightening as an intense debate, which again indicates that the liquidity contraction is nearing an end.

The impact of this transformation on the market is profound. This is the pipeline for Bitcoin trading: it is not the nominal interest rate, but rather whether the system reserves are rising or falling. As the quantitative tightening policy comes to an end, marginal dollars are flowing back into banks and market liquidity, indirectly stimulating risk-taking and demand for cryptocurrencies.

Chain Effects of Exhausted RRP:

Liquidity buffer disappears: Shift from RRP to direct consumption of bank reserves

Tightening of Credit Conditions: Reduced bank reserves increase short-term borrowing costs

Actual Yield Increase: Liquidity pressure raises real Interest Rates

US Dollar Strength Pressure: Liquidity tightening typically supports the US dollar.

Risk assets under pressure: High-risk assets such as Bitcoin are facing selling pressure.

Chairman Powell's speech confirmed that the Federal Reserve believes the current policy is “sufficiently tight” and is ready to adjust its quantitative tightening strategy to maintain “adequate reserves.” This guidance has a more significant impact on risk assets than the Federal Reserve's interest rate cuts themselves.

Real Yield vs. USD: The True Driving Force of Bitcoin

Research consistently shows that forward guidance and balance sheet expectations have a greater impact on long-term real yields than policy interest rates, subsequently affecting risk appetite and ETF demand. A pause in quantitative tightening, or even just rumors of a pause, would lower the opportunity cost of holding Bitcoin, weaken the dollar, and stimulate inflows into spot Bitcoin ETFs.

Before the meeting, the actual yield had fallen from the summer peak. The yield on 10-year Treasury Inflation-Protected Securities (TIPS) hovers around 1.7%, while the 5-year forward inflation expectation is close to 2.2%, indicating a softening of real interest rates and stabilizing inflation. The US dollar index is close to 99, significantly retreating from the year's high. These trends collectively laid the foundation for the liquidity easing policy that emerged after the Federal Reserve shifted to a dovish stance.

The real yield is the nominal interest rate minus the expected inflation, representing the actual return. When the real yield decreases, the opportunity cost of holding non-interest-bearing assets (such as gold and Bitcoin) decreases, as the real returns from traditional fixed-income assets like bonds diminish. This makes assets like Bitcoin relatively more attractive.

The trend of the US dollar is also crucial. Bitcoin, as a global asset priced in US dollars, typically has an inverse relationship with the US dollar index. When the dollar weakens, dollar-denominated assets (including commodities and cryptocurrencies) tend to rise. The opposite is also true. The US dollar index has fallen from its high at the beginning of the year to 99, providing a favorable macro environment for Bitcoin.

Ultimately, as RRP balances are depleted and QT approaches its end, liquidity guidance rather than a 25 basis point rate cut by the Federal Reserve (FED) will determine actual yields and the direction of the dollar, both of which are key driving factors for Bitcoin's short-term direction. This understanding is crucial for assessing the future trend of Bitcoin.

Bitcoin ETF fund flow verifies macro logic

ETF data also corroborated this correlation. In the week prior to the earnings report announcement, the US spot Bitcoin fund recorded a net inflow of approximately $446 million, reversing the weak situation in the middle of the month. A similar follow-up effect was observed after the previous FOMC rate cut: softening real yields and a weakening dollar often lead to a significant increase in ETF issuance within the next 48 hours.

This model is not a coincidence, but a specific manifestation of macro Liquidity being transmitted to the crypto market. When The Federal Reserve (FED) releases signals of easing, institutional investors adjust their asset allocation, shifting from fixed income assets to risk assets. Bitcoin ETF, as the main channel for institutional participation in the crypto market, naturally becomes the preferred target for capital inflows.

As actual interest rates decline and the dollar softens today, traders will focus on whether this trend will reoccur at the end of the week. If Powell's tone remains dovish and the talk of a pause in quantitative tightening is reinforced, actual interest rates are expected to decline, the dollar will weaken, and ETF inflows will increase: this is a constructive situation for Bitcoin.

However, Powell hinted at the post-meeting press conference that there may not be another interest rate cut in December, revealing that The Federal Reserve (FED) officials hold “completely different views” on whether another interest rate cut should occur in December. This statement may limit the space for actual yield declines, thereby constraining the upward momentum of Bitcoin.

Powell's tone determines the short-term direction

If Powell takes measures to be vigilant against inflation again, these results are likely to disappear. What the market is most concerned about is not the magnitude of a single rate cut, but the Federal Reserve's forward guidance on future policy paths. Powell's wording and tone at the press conference will determine how the market interprets the true intentions behind the Federal Reserve's rate cuts.

In a dovish scenario, if Powell emphasizes that “inflationary pressures continue to ease,” “the labor market is showing signs of weakness,” and clearly states that “QT will end soon” and “reserve levels will remain ample,” the market will interpret this as the beginning of a liquidity easing cycle. This will drive real yields down, weaken the dollar, and accelerate capital inflows into Bitcoin ETFs.

In a hawkish scenario, if Powell emphasizes that “inflation risks have not been completely eliminated,” that “the labor market remains healthy,” and states that “the December rate cut is uncertain” and “the end date for QT is undetermined,” the market will interpret this as the Federal Reserve maintaining caution, with limited liquidity easing. This will restrict the space for real yields to decline, the dollar may rebound, and Bitcoin will face adjustment pressure.

The current situation is that Powell hinted that there will be no interest rate cuts in December and emphasized that officials' views are “entirely different,” leaning towards a hawkish stance. This statement may suppress market expectations for liquidity easing in the short term. However, the confirmation of the end of QT is a substantial positive, and as RRP is exhausted and bank reserves stop declining, the liquidity environment will continue to marginally improve.

For Bitcoin investors, the key is to track the changes in real yields and the dollar index, rather than focusing excessively on nominal interest rates. If real yields continue to decline and the dollar weakens, Bitcoin may still rise even if The Federal Reserve (FED) pauses rate cuts. Conversely, if real yields rebound and the dollar strengthens, Bitcoin may come under pressure even if The Federal Reserve (FED) continues to cut rates.