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Experts predict that the crypto markets are poised for a downturn as liquidity constraints make a comeback after the resolution of the U.S. debt ceiling.

In the upcoming months, the removal of hundreds of billions of dollars from the financial system due to the replenishment of the U.S. Treasury general account and the Federal Reserve (Fed) winding down its balance sheet is expected to exert downward pressure on cryptocurrency prices.

Earlier this year, improved liquidity conditions played a crucial role in boosting the prices of various risk assets, including equities and digital assets. The widespread surge in the crypto market led to the remarkable ascent of bitcoin (BTC), the leading cryptocurrency in terms of market capitalization, reaching highs of up to $31,000. However, this rally later transformed into a speculative frenzy reminiscent of the irrational exuberance observed near the peak of bull markets, particularly associated with meme coins.

The trend is expected to shift soon as U.S. lawmakers give their approval for increasing the government's capacity to issue additional debt, which will exert pressure on high-risk investments.

To begin with, the U.S. Treasury needs to replenish its nearly exhausted Treasury General Account (TGA), which entails restoring approximately $500 billion of cash from the financial system.

“This is likely to especially hit risk assets as they tend to be more sensitive to liquidity conditions than safer plays such as bonds and many groups of equities,” macro analyst Noelle Acheson said.

“The Treasury drawing down its account at the Fed was one of the tailwinds for the market earlier this year, as money that would normally just sit there was put into the economy in the form of government expenditures,” Acheson explained.

“Now, the reverse is likely to happen: the government needs to replenish that account balance by issuing debt which will draw liquidity out of the market and back into the Treasury's account.”

As the Federal Reserve proceeds with its quantitative tightening campaign, interrupted briefly in March by the regional banking crisis, the refilling of the general account aligns with its objective of reducing the inflated balance sheet that supported the economy during the pandemic.

In a market report, macro analyst Lyn Alden described this as a "detrimental double blow to liquidity."

“The attractiveness of many large liquidity-driven equities is lackluster for the next few months unless or until we get more clarity on forward liquidity conditions,” Alden said. “This is an environment where an investor should know what they own, be prepared for volatility and avoid excessive leverage.”

Tom Dunleavy, the founder of Dunleavy Investment Research, contends that the current iteration of the debt ceiling resolution bill will not only have a detrimental impact on liquidity but also exacerbate the existing challenges.

In a tweet, Dunleavy elaborated on several crucial aspects of the deal that will limit the remaining funds available for consumers to invest. These include reducing non-defense funding, reclaiming unutilized pandemic relief funds, and resuming student loan payments. According to Dunleavy, these measures will result in a significant net negative liquidity situation.

 

 

The U.S. House of Representatives is set to hold a vote on increasing the debt ceiling Wednesday evening.

FalconX, an institutional trading platform, highlighted in their newsletter that the convergence of factors such as tightening liquidity conditions, a decreasing possibility of the Fed cutting interest rates this year, and the prevailing trading environment characterized by subdued volatility and volumes, has created an environment in crypto markets that is primed for a potential shock.

“This macro scenario (...) makes me believe we could be in a calm-before-the-storm moment for crypto,” David Lawant, head of research at FalconX, said.