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Observers say BTC price and crypto market are primed for a downturn in the coming liquidity shock

Crypto markets are preparing for a downturn as liquidity crunches resume after the US debt ceiling was lifted, observers said.

The replenishment of the US Treasury and the Federal Reserve (Fed) unwinding its balance sheet will drain hundreds of billions of dollars from the financial system, which will weigh on cryptocurrency prices in the coming months.

The thawing of liquidity conditions earlier this year helped lift the prices of risky assets, including stocks and digital assets. The market-wide crypto rally propelled Bitcoin (BTC), the largest cryptocurrency by market cap, as high as $31,000 before turning into a meme coin speculative frenzy reminiscent of the sugar rush near bull market highs.

However, the trend is likely to reverse once US lawmakers approve an increase in the government’s ability to issue new debt, increasing pressure on risky investments.

First, the US Treasury Department needs to replenish its nearly depleted Treasury General Account (TGA), which means about $500 billion in cash needs to be replenished from the financial system.

“Risk assets are likely to be particularly affected as they tend to be more sensitive to liquidity conditions than safer assets such as bonds and many equity groups,” said macro analyst Noelle Acheson.

“The Treasury Department’s termination of its account with the Fed was one of the market’s tailwinds earlier in the year as money that would normally be sitting there was injected into the economy in the form of government spending,” Acheson said.

“Now the opposite is likely to happen: the government needs to replenish that account balance by issuing debt, pulling liquidity from the market back into the Treasury account.”

The replenishment of the overall account coincides with the continuation of the Fed’s quantitative tightening campaign, which was briefly paused in March due to the regional banking crisis to reduce its bloated balance sheet, which is not supporting the economy during the pandemic.

Macro analyst Lyn Alden called this a “negative double whammy for liquidity” in a market report.

“The appeal of many large liquidity-driven stocks will be lacking over the next several months unless or until we get more clarity on future liquidity conditions,” Alden said. “This is an environment in which an investor should know what they own, be prepared for volatility and avoid excessive leverage.”

According to Tom Dunleavy, founder of Dunleavy Investment Research, the debt ceiling solution bill – if passed in its current form – will also contribute to the negative impact on liquidity.

Some key points of the deal, such as cutting non-defense funding, recovering unspent pandemic relief funds and resuming student loan payments, would limit the available money consumers still have to invest, he explained in a tweet. “Liquidity will be very negative on balance,” Dunleavy added.

The US House of Representatives will vote on raising the debt ceiling on Wednesday evening.

Tightening liquidity conditions, the decreasing likelihood that the Fed will cut interest rates this year, and the current trading environment of low volatility and lower volumes are making crypto markets ripe for a shock, institutional trading platform FalconX wrote in a newsletter.

“This macro scenario (…) leads me to believe that we could be in a moment of calm before the storm for crypto,” said David Lawant, Research Director at FalconX.

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