Analysis of the Effectiveness of the Relationship Between Fed Monetary Policy and Liquidity: Evaluation of Bitcoin as a Liquidity Proxy Indicator

Based on data analysis for the period 2024-2025, the effectiveness of Bitcoin price as a liquidity proxy indicator has significant limitations. Although the Federal Reserve implemented consecutive interest rate cuts, Bitcoin prices did not show the expected trend of improved liquidity in the traditional sense, but instead experienced large fluctuations. This reflects the complexity of the liquidity transmission mechanism and the interaction of multiple influencing factors in the modern financial environment.

The traditional transmission paths of monetary policy affecting liquidity include:

• Interest rate channel
  : Interest rate cuts reduce capital costs, promoting borrowing and investment
• Asset price channel
  : Increased liquidity pushes up asset prices
• Confidence channel
  : Policy easing improves market expectations and risk appetite

Reasons Bitcoin may become a liquidity proxy indicator:

• High sensitivity
  : Sensitive to changes in liquidity
• Global characteristics
  : Not restricted by single-country policies
• 24/7 trading
  : Reflects market sentiment changes in real time
• Speculative nature
  : Tends to perform strongly when liquidity is abundant

• Bitcoin rose by 94.92% during the period, far exceeding the S&P 500 (44.02%) and Nasdaq 100 (51.65%) [0]
• Bitcoin’s annualized volatility reached 40.24%, significantly higher than traditional assets [0]
• Low correlation with traditional assets (0.369-0.371), showing uniqueness [0]

According to data, the Federal Reserve implemented the following key policies in 2024:

• September 18, 2024
  : First 25 basis point rate cut
• November 7, 2024
  : Second rate cut
• December 12, 2024
  : Third rate cut
• January 29, 2025
  : Fourth rate cut

The Federal Reserve officially ended quantitative tightening (QT) on December 1, 2025 [1]:

• Balance sheet frozen at $6.57 trillion
• 2.39 trillion USD of liquidity withdrawn from the system
• Standing repo facility becomes a permanent liquidity provider

1. High volatility characteristic
   : Bitcoin’s 40.24% annualized volatility reflects sensitivity to liquidity changes [0]
2. Independent trend
   : Low correlation with traditional assets, providing additional information
3. Fast response mechanism
   : 24/7 trading allows rapid response to liquidity changes

1. Deviation from traditional theory
   : Bitcoin did not show sustained growth after rate cuts
2. Multiple influencing factors
   : Bitcoin price is affected by technical factors, regulatory policies, institutional acceptance, etc.
3. Excessive speculation
   : Over-speculation may mask liquidity signals

Research finds that U.S. fiscal policy may have a greater impact on liquidity than monetary policy:

• Developed market government debt is expected to grow by $6 trillion to $71 trillion in 2025, accounting for 105% of GDP [2]
• U.S. government debt-to-GDP ratio is expected to reach 122% by the end of 2027 [2]
• By 2035, the federal debt burden may rise to 134% of GDP [3]

• Large-scale treasury bond issuance absorbs liquidity
• Government spending targets specific areas
• Tax policies directly affect corporate and household disposable income

1. Interest rate transmission钝化
   : Zero interest rate lower bound policy weakens the effect of the interest rate channel
2. Bank credit constraints
   : Tighter banking regulation limits credit expansion
3. Complexity of expectation management
   : Decline in policy credibility affects expectation formation

1. Direct asset purchases
   : Central banks directly purchase various assets
2. Unconventional tools
   : Repo facilities, term lending facilities, etc.
3. Cross-border liquidity spillovers
   : Enhanced global liquidity linkage effects

1. Diversified liquidity indicator monitoring
   :
   • Traditional indicators: M2 money supply, bank reserves
   • Market indicators: TED spread, commercial paper interest rate
   • Alternative indicators: Bitcoin, gold and other commodities

2. Dynamic allocation adjustment
   :
   • Increase allocation to assets sensitive to fiscal policy
   • Focus on industries benefiting from government spending
   • Moderately allocate safe-haven assets to hedge policy uncertainty

1. Liquidity risk management
   :
   • Maintain sufficient cash buffers
   • Avoid over-concentration in highly correlated assets
   • Establish multi-level liquidity sources

2. Policy risk hedging
   :
   • Use derivatives to hedge interest rate risk
   • Geographical diversification to reduce single-country policy impact
   • Industry diversification to cope with structural policy adjustments

1. Limitations of Bitcoin as a liquidity proxy indicator
   : Although Bitcoin shows sensitivity to liquidity, its effectiveness as a single liquidity proxy indicator is limited due to multiple influencing factors.

2. Dominant position of fiscal policy
   : In the current environment, U.S. fiscal policy may have a greater impact on liquidity than traditional monetary policy.

3. Transformation of liquidity transmission mechanism
   : The effect of the traditional interest rate transmission mechanism has declined, and new liquidity transmission channels are forming.

1. Increased importance of policy coordination
   : Coordination between monetary and fiscal policies will become a key factor affecting liquidity.

2. Evolution of liquidity indicator system
   : Need to build a more comprehensive liquidity monitoring system, including traditional and alternative indicators.

3. Enhanced global liquidity linkage
   : Policy spillover effects from various countries will have a profound impact on the global liquidity pattern.

[0] Gilin API Data - Bitcoin and U.S. Stock Index Price Data (2024-2025)

[1] Yahoo Finance - “Tomorrow the Fed Ends QT — Crypto Thinks the Melt-Up Starts Now” (https://finance.yahoo.com/news/tomorrow-fed-ends-qt-crypto-195200403.html)

[2] Yahoo Finance - “How soaring government debt could play a starring role in…” (https://ca.finance.yahoo.com/news/soaring-government-debt-could-play-194242539.html)

[3] Moody’s Ratings - “Moody’s Ratings downgrades United States…” (https://links.message.bloomberg.com/s/c/47sfUA0FINQZ5Jfz4Ou8xCoYpUdaOOHWBI62f4EdMP3KVTJQqhfXEMlm7_-nHa8umeYv_UGWBNVA2kRmvxoAV5XhdgazHEkM97yJ9k2o4Tl8he5WvK_ajzxD0otMTEhmpmmOdvcv7BftFVL5QXi4QN8oTdhSyarAgeRv4T5Gi8_nDxl7v3vxnmSN55rPYtmHZsllAE8WiGAWzsiNGkhr0DXM4rSv3UN8do2a60BdtlEguwILg7hz3_uhzcK8lD8sci5MOOMJrLgDKK3unNHkkgCHwdVXkf3sPfIuGY745_Gb2lJkORodj2llg/tVI2PIcBb0VJ0Cgf__1NMEyj8wNV269/9)