Bank of America Hartnett: Everything has reached a "liquidity peak," and the Federal Reserve will be forced to "surrender," with Bitcoin being the first to sniff out the market rescue signals

Recently, the market has shown significant divergence in its judgment of the Federal Reserve's interest rate path for December. Previously, due to moderate inflation and weak labor data, the market generally believed that another rate cut in December was almost a foregone conclusion; however, a series of hawkish statements from the Federal Reserve recently dampened this optimistic expectation. Although some officials released dovish signals on Friday, the debate over the direction of monetary policy at the end of the year has not yet subsided.

Michael Hartnett, Chief Investment Strategist at Bank of America, stated in the latest "Flow Show" report that based on the current tightening of liquidity impacting multiple asset classes, the Federal Reserve is facing pressure to continue cutting rates, and the cryptocurrency market will become the first barometer to sense the central bank's policy shift.

Hartnett pointed out that assets such as cryptocurrencies, credit, the dollar, and private equity have all shown "liquidity peak" signals. Over the past two years, the global central banks' multiple rate cuts have fueled speculative sentiment in the market, but recent hawkish remarks from the Federal Reserve have raised doubts about further easing policies in 2026. Cryptocurrencies have been severely impacted, with Bitcoin and Ethereum continuing to decline, highlighting the impact of liquidity tightening on risk assets.

Hartnett expects that the current weakness in U.S. bank stocks is sending signals similar to those seen in December 2018, and the continued decline in liquidity-sensitive sectors may force the Federal Reserve to shift towards easing policies. Looking back at 2025, the cumulative 316 rate cuts by global central banks have triggered a liquidity feast, directly driving three market phenomena: the AI investment frenzy, significant fluctuations in Japanese stocks, and cryptocurrency speculation.

Looking ahead to 2026, Hartnett predicts that the Federal Reserve will repeat "policy surrender" and be forced to initiate a rate-cutting cycle. In this scenario, three types of assets will benefit the most: first, long-term zero-coupon bonds, whose duration advantage will directly realize the valuation premium brought by falling interest rates; second, Bitcoin, which, as the asset most sensitive to liquidity, has historically surged before the full implementation of market rescue signals; third, mid-cap stocks, which are most sensitive to financing costs and will show significant profit elasticity and rebound potential after rate cuts are realized.

Japan's Debt Crisis Intensifies Global Liquidity Concerns

Japan is facing a crisis of simultaneous collapse in bonds and the yen. The 30-year government bond has fallen 5% in the past two weeks, with a cumulative decline of 12% for the year, marking the worst performance since the 1970s; the yen's exchange rate against the dollar is approaching the 160 mark, hitting a 40-year low.

At the same time, there is a clear mismatch at the policy level. The newly appointed Japanese Prime Minister has introduced a large-scale fiscal stimulus amounting to 3% of GDP, while the Bank of Japan's actual policy interest rate remains at -2%. This combination of "expansive fiscal policy + loose monetary policy" has exacerbated the depreciation of the yen and the pressure on government bonds.

Japanese government bond yields have broken through key resistance levels, contrasting sharply with the warming trend in the global bond market. Policymakers are caught in a dilemma: if they raise interest rates to control inflation, it may trigger a stock market crash; if they maintain easing, both the currency and government bonds will continue to be under pressure. This crisis is spreading globally through the unwinding chain of carry trades, and rising Japanese bond yields may trigger a return of international capital, impacting dollar liquidity and subsequently affecting U.S. stocks, credit bonds, and the cryptocurrency market

Signals of Liquidity Tightening Appear Frequently in Multiple Markets, Federal Reserve Policy Shift Imminent

U.S. mid-cap stocks currently show a significant divergence between valuation and performance. Despite valuations being at a low of 15 times, and benefiting from easing trade tensions and a trend of manufacturing returning, their performance has remained under pressure throughout the year. This contradictory phenomenon highlights that the Federal Reserve's policy adjustments have significantly lagged behind actual market demand.

The bank stock index has fallen below 140, and the brokerage index has dropped below 950; these two sectors, which are highly sensitive to liquidity, have historically been leading indicators of policy shifts. As seen in the market experience of December 2018, they will be the first to respond to potential liquidity easing.

Hartnett believes that signals indicating the Federal Reserve needs to continue cutting interest rates have emerged. Over the past two years, global central banks have cut rates a total of 316 times, driving a "collective euphoria" in the market, with investors generally expecting more rate cuts in 2026. However, the recent hawkish statements from the Federal Reserve have raised some concerns.

At the same time, Hartnett emphasizes that when the Federal Reserve is forced to cut rates significantly, the market will present numerous investment opportunities. Historical experience shows that a "surrender" in central bank policy often brings significant revaluation opportunities for risk assets.

Cryptocurrency Becomes a Barometer for Policy Shifts

Hartnett believes that digital assets like Bitcoin will become the "canary in the coal mine" for sensing changes in central bank policy, with their price movements providing important policy warning signals for investors. This judgment is based on the cryptocurrency market's high sensitivity to liquidity changes and its rapid response capability.

Despite recent severe setbacks in the cryptocurrency market, with both Bitcoin and Ethereum plummeting, Hartnett believes that cryptocurrencies will be the first to sense the Federal Reserve's market rescue actions. According to a Bank of America fund manager survey in November, cryptocurrencies account for only 0.4% of institutional asset allocation, but retail funds flowing into the cryptocurrency market are expected to reach a record $46 billion by 2025. Derivative trading currently accounts for 74% of cryptocurrency trading volume, making it a frontline area for liquidity and speculation.

Although institutional investors' allocation to cryptocurrencies is limited, the significant influx of retail funds indicates a strong market expectation for liquidity easing. Once the Federal Reserve signals a policy shift, the cryptocurrency market may rebound first.