The United States economy has been experiencing a period of turbulence in recent times. Over the past 12 months, the U.S. Personal Consumption Expenditure (PCE) inflation index has risen significantly by 3.5%. Even when excluding the volatile food and energy sectors, it is clear that the U.S. Federal Reserve’s efforts to curb inflation have fallen short of their 2% target rate.
As a result of these rate hikes, U.S. Treasurys have lost a staggering $1.5 trillion in value. This has raised concerns among investors about whether Bitcoin (BTC) and other risk-on assets, including the stock market, will be able to withstand the impact of higher interest rates and the monetary policy aimed at cooling economic growth.
The U.S. Treasury’s continued flooding of the market with debt poses a real risk of further rate increases, which could exacerbate the losses for fixed-income investors. An additional $8 trillion in government debt is set to mature in the next 12 months, adding to the already existing financial instability.
Financial circles are growing increasingly concerned that the central bank may tighten its policies to such an extent that it results in severe disruptions to the financial system. Daniel Porto, the head of Deaglo London, has voiced these concerns, questioning whether the current course can be sustained without causing significant damage.
The rise in interest rates has been one of the main drivers behind the recent turmoil in financial markets. As rates increase, the prices of existing bonds fall, a phenomenon referred to as interest rate risk or duration. This risk affects not only specific groups but also countries, banks, companies, and individuals holding fixed-income instruments.
In September alone, the Dow Jones Industrial Index experienced a 6.6% drop. Additionally, the yield on the U.S. 10-year bonds reached 4.7% on Sept. 28, its highest level since August 2007. This surge in yields indicates that investors are becoming increasingly cautious about holding long-term bonds, even those issued by the government.
Banks, which typically borrow short-term instruments and lend for the long term, are particularly vulnerable in this environment. They rely on deposits and often hold Treasurys as reserve assets. When the value of Treasurys declines, banks may find themselves short of the necessary funds to meet withdrawal requests. This forces them to sell Treasurys and other assets, bringing them dangerously close to insolvency and potentially requiring rescue by institutions such as the Federal Deposit Insurance Corporation or larger banks. The collapse of Silicon Valley Bank, First Republic Bank, and Signature Bank serves as a warning of the potential instability in the financial system.
Although emergency mechanisms like the Federal Reserve’s emergency loan Bank Term Funding Program can offer some relief by allowing banks to use impaired Treasurys as collateral, these measures do not erase the losses entirely. Banks are increasingly offloading their holdings to private credit and hedge funds, leading to a flooding of these sectors with rate-sensitive assets. This trend could worsen if the debt ceiling is raised to avoid a government shutdown, further driving up yields and amplifying losses in the fixed-income markets.
As long as interest rates remain high, the risk of financial instability will continue to grow. This could prompt the Federal Reserve to provide support to the financial system through emergency credit lines. In this environment, assets like Bitcoin can prove highly beneficial due to increasing inflation and the worsening profile of the Federal Reserve’s balance sheet, as evidenced by the $1.5 trillion paper losses in U.S. Treasurys.
Predicting the timing of such an event is nearly impossible, let alone predicting the outcomes if larger banks consolidate the financial system or if the Federal Reserve effectively guarantees liquidity for troubled financial institutions. However, under these circumstances, it is difficult to find a scenario where one would be pessimistic about Bitcoin.
It is important to note that this article is for general information purposes and should not be taken as legal or investment advice. The views and opinions expressed here are solely those of the author and do not necessarily reflect the views and opinions of Cointelegraph.