Arthur Hayes Blog: The Activation of SRF and Implicit Quantitative Easing

Author: Arthur Hayes

Original Title: Hallelujah

Compiled and organized by: BitpushNews

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Introduction: The Inevitability of Political Incentives and Debt

Praise to Satoshi Nakamoto, the existence of time and the rule of compound interest, independent of individual identity.

Even for the government, there are only two ways to pay expenses: using savings (tax revenue) or issuing debt. For the government, savings are equivalent to tax revenue. It is well known that taxes are not popular among the public, but spending money is quite appealing. Therefore, when distributing benefits to the common people and the nobility, politicians tend to prefer issuing debt. Politicians always tend to borrow against the future to ensure their current re-election, because by the time the bills come due, they are likely no longer in office.

If all governments are “hard-coded” by the incentives of officials to prefer issuing debt rather than raising taxes to distribute benefits, then the next key question is: how do the purchasers of U.S. government bonds finance these purchases? Do they use their own savings/equity, or do they finance through borrowing?

Answering these questions, especially in the context of “Pax Americana,” is crucial for our predictions about future dollar currency creation. If the marginal buyers of U.S. government debt complete their purchases through financing, we can observe who is providing them with loans. Once we know the identities of these debt financiers, we can determine whether they are creating money ex nihilo to lend or using their own equity to make loans. If, after answering all the questions, we find that the financiers of the government debt are creating money in the lending process, then we can draw the following conclusion:

Government-issued debt will increase the money supply.

If this assertion holds true, then we can estimate the upper limit of the credit that the financing party can issue (assuming there is an upper limit).

The reason these issues are important is that my argument is: if government borrowing continues to grow as predicted by large banks (TBTF Banks), the U.S. Treasury, and the Congressional Budget Office, then the Federal Reserve's balance sheet will also grow. If the Federal Reserve's balance sheet grows, it will mean a beneficial liquidity for the dollar, which will ultimately drive up the prices of Bitcoin and other cryptocurrencies.

Next, we will answer the questions one by one and evaluate this logic puzzle.

Q&A session

Will President Trump finance the deficit through tax cuts?

No. He has recently extended the 2017 tax cut policy with the Republican “red camp.”

Is the U.S. Treasury borrowing money to cover the federal deficit, and will it continue to do so in the future?

Yes.

The following are estimates from major bankers and U.S. government agencies. As can be seen, they predict a deficit of about $2 trillion, financed through $2 trillion in borrowing.

Given that the answers to the first two questions are both “yes”, then:

Annual federal deficit = Annual government bond issuance

Next, we will analyze step by step the main buyers of government bonds and how they finance their purchases.

“Waste” that devours debt

1. Foreign central banks

If the “peace under the United States” is willing to steal the funds of Russia (a nuclear power and the world's largest commodity exporter), then no foreign holder of U.S. Treasuries can ensure safety. Foreign central bank reserve managers are aware of the risks of expropriation, and they prefer to buy gold rather than U.S. Treasuries. Therefore, since Russia invaded Ukraine in February 2022, gold prices have started to soar.

2. Private Sector in the United States

According to data from the U.S. Bureau of Labor Statistics, the personal savings rate for 2024 is 4.6%. In the same year, the U.S. federal deficit is 6% of GDP. Given that the deficit is larger than the savings rate, the private sector cannot become the marginal buyer of government bonds.

3. Commercial Banks

Are the four major currency center commercial banks buying a large amount of US Treasury bonds? The answer is no.

In the fiscal year 2025, these four major currency center banks purchased approximately $300 billion worth of U.S. Treasuries. In the same fiscal year, the Treasury issued $1.992 trillion in U.S. Treasuries. Although these buyers are undoubtedly important purchasers of U.S. Treasuries, they are not the ultimate marginal buyers.

4. Relative Value (RV) Hedge Fund

The RV fund is the marginal buyer of government bonds, a fact acknowledged in a recent document by the Federal Reserve.

Our findings indicate that hedge funds in the Cayman Islands are increasingly becoming marginal foreign buyers of U.S. Treasuries and bonds. As shown in Figure 5, from January 2022 to December 2024—during this period the Federal Reserve reduces its balance sheet by allowing maturing U.S. Treasuries to roll off its portfolio—hedge funds in the Cayman Islands net purchased $1.2 trillion in Treasuries. Assuming these purchases were entirely composed of Treasuries and bonds, they absorbed 37% of the net issuance of Treasuries and bonds, nearly equivalent to the total amount purchased by all other foreign investors.

Trading model of RV fund:

1. Buy spot government bonds

2. Sell the corresponding government bond futures contracts

Thanks to Joseph Wang for the chart. SOFR trading volume is a proxy for measuring the size of RV funds' participation in the Treasury market. As you can see, the growth of the debt burden corresponds to an increase in SOFR trading volume. This indicates that RV funds are the marginal buyers of Treasuries.

The RV fund conducts this type of transaction to profit from the small price difference between the two instruments. Since this price difference is extremely small (measured in basis points; 1 basis point = 0.01%), the only way to make a profit is to finance the purchase of government bonds.

This leads us to the most important part of this article, which is to understand the Federal Reserve's next move: how RV funds finance the purchase of government bonds?

Part Four: Repurchase Market, Implicit Quantitative Easing, and Dollar Creation

The RV fund finances its government bond purchases through repurchase agreements (repos). In a seamless transaction, the RV fund uses the purchased government bond securities as collateral, borrows overnight cash, and then uses this borrowed cash to settle the government bonds. If cash is abundant, the repurchase rate will trade at or just below the upper limit of the Federal Reserve's federal funds rate. Why?

How the Federal Reserve Manipulates Short-Term Interest Rates

The Federal Reserve has two policy interest rates: the upper limit of the federal funds rate (Upper Fed Funds) and the lower limit (Lower Fed Funds); currently, they are 4.00% and 3.75%, respectively. In order to enforce the actual short-term rate (SOFR, the secured overnight financing rate) within this range, the Federal Reserve has used the following tools (sorted by interest rate from low to high):

1. Overnight Reverse Repurchase Agreement (RRP): Money Market Funds (MMF) and commercial banks deposit cash here overnight to earn interest paid by the Federal Reserve. Reward rate: Lower bound of the federal funds rate.

2. Interest on Reserve Balances (IORB): The excess reserves that commercial banks hold at the Federal Reserve earn interest. Reward rate: between the upper and lower limits.

3. Standing Repo Facility (SRF): When cash is tight, it allows commercial banks and other financial institutions to pledge eligible securities (primarily U.S. Treasuries) and obtain cash from the Federal Reserve. Essentially, the Federal Reserve prints money in exchange for the pledged securities. Reward Rate: Upper limit of the federal funds rate.

Relationship among the three:

The lower bound of the federal funds rate = RRP < IORB < SRF = The upper bound of the federal funds rate

SOFR (Secured Overnight Financing Rate) is the target interest rate set by the Federal Reserve, representing a composite rate for various repurchase agreements. If the SOFR trading price exceeds the upper limit of the federal funds rate, it indicates cash tightness in the system, which could lead to significant problems. Once cash tightness occurs, SOFR will soar, and the highly leveraged fiat financial system will come to a halt. This is because, if the marginal liquidity buyers and sellers cannot roll over their liabilities near the predictable federal funds rate, they will incur huge losses and stop providing liquidity to the system. No one will buy U.S. Treasury bonds because they cannot obtain cheap leverage, resulting in the U.S. government being unable to finance at an affordable cost.

Exit of marginal cash providers

What causes the SOFR trading price to be above the upper limit? We need to examine the marginal cash providers in the repo market: money market funds (MMFs) and commercial banks.

Exit of Money Market Funds (MMF): The goal of MMF is to earn short-term interest with minimal credit risk. Previously, MMFs would withdraw funds from RRP and shift to the repo market because RRP < SOFR. However, now, due to the highly attractive yields on short-term T-bills, MMFs are pulling funds out of RRP and lending to the U.S. government. The RRP balance has dropped to zero, and MMFs have essentially exited the cash supply of the repo market.

Restrictions of Commercial Banks: Banks are willing to provide reserves to the repurchase market because IORB < SOFR. However, a bank's ability to provide cash depends on whether its reserves are sufficient. Since the Federal Reserve began quantitative tightening (QT) in early 2022, bank reserves have decreased by trillions of dollars. Once the balance sheet capacity shrinks, banks are forced to charge higher interest rates to provide cash.

Since 2022, both MMF and banks, as marginal cash providers, have had less cash to supply to the repurchase market. At a certain point, neither was willing or able to provide cash at a rate lower than or equal to the upper limit of the federal funds rate.

At the same time, the demand for cash is rising. This is because former President Biden and the current Trump continue to spend lavishly, calling for the issuance of more government bonds. The marginal buyers of government bonds, RV funds, must finance these purchases in the repurchase market. If they cannot obtain daily funding at rates below or slightly below the upper limit of the federal funds rate, they will stop buying U.S. Treasuries, and the U.S. government will be unable to finance itself at affordable rates.

The activation of SRF and Stealth QE

Due to a similar situation in 2019, the Federal Reserve established the SRF (Standing Repo Facility). As long as acceptable collateral is provided, the Federal Reserve can provide an unlimited amount of cash at the SRF rate (i.e., the upper limit of the federal funds rate). Therefore, RV funds can be assured that no matter how tight cash may be, they can always obtain funding at the worst-case scenario—the upper limit of the federal funds rate.

If the SRF balance is above zero, we know that the Federal Reserve is cashing the checks written by politicians with printed money.

Government bond issuance = Increase in dollar supply

The above figure (top panel) shows the difference between (SOFR – the upper limit of the federal funds rate ). When this difference approaches zero or is positive, cash becomes tight. During these periods, the SRF (bottom panel, measured in billions of dollars) is significantly utilized. Using SRF allows borrowers to avoid paying higher, less manipulated SOFR rates.

Stealth QE: The Federal Reserve has two methods to ensure there is ample cash in the system: the first method is to create bank reserves by purchasing bank securities, which is known as Quantitative Easing (QE). The second method is to freely lend to the repurchase market through the SRF.

QE is now considered a “dirty word,” with the public generally associating it with money printing and inflation. To avoid being accused of causing inflation, the Federal Reserve will strive to assert that its policies are not QE. This means that SRF will become the primary channel for money printing to flow into the global financial system, rather than creating more bank reserves through QE.

This can only buy some time. But ultimately, the exponential expansion of government bond issuance will force the SRF to be used repeatedly. Remember, Treasury Secretary Buffalo Bill Bessent not only needs to issue $20 trillion each year to fund the government but also needs to issue trillions of dollars to roll over maturing debt.

Implicit quantitative easing is about to begin. Although I don't know the exact timing, if the current conditions in the money market persist, with government bonds piling up, the SRF balance as the lender of last resort must increase. As the SRF balance grows, the amount of global fiat currency in US dollars will also expand. This phenomenon will reignite the bull market for Bitcoin.

Part Five: Current Market Stagnation and Opportunities

Before the implicit QE begins, we must control capital. The market is expected to continue to fluctuate, especially before the end of the U.S. government shutdown.

Currently, the Treasury is borrowing money through debt auctions (negative dollar liquidity), but has not yet spent this money (positive dollar liquidity). The balance of the Treasury General Account (TGA) is about $150 billion above the target of $850 billion, and this extra liquidity will only be released into the market after the government reopens. This liquidity siphoning effect is one of the reasons for the current weakness in the crypto market.

As the four-year anniversary of Bitcoin's historical peak in 2021 approaches, many people will mistakenly interpret this period of market weakness and fatigue as a top and will sell their holdings. Of course, this is assuming they weren't “wiped out” in the altcoin crash a few weeks ago.

But this is a mistake. The operating logic of the dollar money market does not lie. This market corner is shrouded in obscure terminology, but once you translate these terms into “printing money” or “destroying currency,” it becomes easy to grasp the trends.