The United States economy has been facing challenging times recently, as the U.S. Personal Consumption Expenditure (PCE) inflation index has risen by a significant 3.5% over the past year. The efforts made by the U.S. Federal Reserve to control inflation and maintain a 2% target rate have fallen short, even when excluding the volatile food and energy sectors.
Due to these rate hikes, U.S. Treasurys have lost a staggering $1.5 trillion in value. This has raised concerns among investors about the impact of higher interest rates and a monetary policy aimed at cooling economic growth on Bitcoin (BTC) and other risk-on assets, including the stock market.
One of the key drivers behind the recent disruptions in financial markets is the rise in interest rates. As rates increase, the prices of existing bonds fall, creating interest rate risk or duration. This risk affects not only specific groups but also countries, banks, companies, individuals, and anyone holding fixed-income instruments.
During September alone, the Dow Jones Industrial Index experienced a 6.6% drop, and the yield on U.S. 10-year bonds reached 4.7%, its highest level since August 2007. This surge in yields indicates that investors are becoming increasingly reluctant to take the risk of holding long-term bonds, even those issued by the government.
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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 Treasurys lose value, banks may find themselves short of the necessary funds to meet withdrawal requests. This could compel them to sell Treasurys and other assets, pushing them dangerously close to insolvency and requiring rescue by 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 financial system instability.
While emergency mechanisms like the Federal Reserve’s emergency loan Bank Term Funding Program can provide some relief by allowing banks to post impaired Treasurys as collateral, these measures do not eliminate the losses. Banks are increasingly offloading their holdings to private credit and hedge funds, flooding these sectors with rate-sensitive assets. This trend is likely to worsen if the debt ceiling is increased to avoid a government shutdown, further increasing 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, prompting the Federal Reserve to support the financial system through emergency credit lines. This situation is highly favorable for scarce assets like Bitcoin, given the increasing inflation and the worsening profile of the Federal Reserve’s balance sheet, as measured by the $1.5 trillion paper losses in U.S. Treasurys.
Predicting the timing of these events is extremely challenging, let alone determining the outcomes if larger banks consolidate the financial system or if the Federal Reserve effectively guarantees liquidity for troubled financial institutions. However, it is unlikely that one would be pessimistic about Bitcoin in such circumstances.
It is important to note that this article provides general information and should not be interpreted as legal or investment advice. The opinions expressed here are solely those of the author and do not necessarily reflect the views and opinions of Cointelegraph.
