The United States economy has been facing turbulent times lately, with the US Personal Consumption Expenditure (PCE) inflation index rising a significant 3.5% over the past 12 months. Even excluding the volatile food and energy sectors, it is clear that the US Federal Reserve’s efforts to curb inflation have not met its target rate of 2%.
US Treasuries have lost a staggering $1.5 trillion in value, primarily due to these rate increases. This has led investors to wonder whether bitcoin (btc) and risk assets, including the stock market, will succumb to rising interest rates and monetary policy aimed at cooling economic growth.
As the US Treasury continues to flood the market with debt, there is a real risk that rates will rise further, exacerbating losses for fixed income investors. An additional $8 trillion in public debt is expected to mature in the next 12 months, further contributing to financial instability.
As Daniel Porto, director of Deaglo London, says, he pointed In comments to Reuters:
“(The Federal Reserve) is going to play a game where inflation is going to lead, but the real question is can we stay this course without causing too much damage?”
Porto’s comments resonate with a growing concern in financial circles: the fear that the central bank could tighten its policies to the point of causing serious disruptions in the financial system.
High interest rates eventually have devastating consequences
One of the main drivers of the recent turmoil in financial markets is rising interest rates. As rates rise, the prices of existing bonds fall, a phenomenon known as interest rate or duration risk. This risk is not limited to specific groups: it affects countries, banks, companies, individuals and anyone who owns fixed income instruments.
The Dow Jones Industrial Average saw a 6.6% drop in September alone. Additionally, the US 10-year bond yield rose to 4.7% on September 28, marking its highest level since August 2007. This rise in yields shows that investors are increasingly reluctant to take on risk of holding long-term bonds. even those issued by the government itself.
Banks, which typically borrow short-term instruments and lend long-term, are especially vulnerable in this environment. They rely on deposits and often hold Treasury bonds as reserve assets.
When Treasury bonds lose value, banks may find themselves without the funds needed to meet withdrawal requests. This forces them to sell Treasuries and other assets, putting them dangerously close to insolvency and requiring bailouts from institutions like 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 instability of the financial system.
The Fed’s shadow intervention could almost run out
While emergency mechanisms, such as the Federal Reserve’s Emergency Loan Term Bank Financing Program, can provide some relief by allowing banks to post deteriorated Treasury bonds as collateral, these measures do not make losses magically disappear. .
Banks are increasingly shifting their holdings into private credit and hedge funds, flooding these sectors with rate-sensitive assets. This trend is about to get worse if the debt ceiling is raised to avoid a government shutdown, which will push yields even higher and amplify losses in fixed income markets.
As long as interest rates remain high, the risk of financial instability grows, leading the Federal Reserve to support the financial system through emergency lines of credit. This is highly beneficial for scarce assets like bitcoin, given rising inflation and the worsening profile of the Federal Reserve’s balance sheet as measured by paper losses of $1.5 trillion on US Treasuries.
It is almost impossible to time this event, much less what would happen if the largest banks consolidate the financial system or if the Federal Reserve effectively guarantees liquidity to troubled financial institutions. Still, there is hardly a scenario in which one can be bearish on bitcoin under those circumstances.
This article is for general information purposes and is not intended to be and should not be taken as legal or investment advice. The views, thoughts and opinions expressed here are solely those of the author and do not necessarily reflect or represent the views and opinions of Cointelegraph.
