Bitcoin’s inflation-hedge theory tested as rising interest rates bring turbulence to markets
The recent turbulence in the United States economy and the rise in inflation have raised concerns among investors and analysts. The U.S. Personal Consumption Expenditure (PCE) inflation index has surged by 3.5% over the past year, surpassing the target rate set by the U.S. Federal Reserve. Despite the efforts made by the Federal Reserve to control inflation, it seems that their measures have fallen short.
The rise in inflation has had significant repercussions for U.S. Treasurys, which have lost a staggering $1.5 trillion in value. This has led investors to question whether Bitcoin and other risk-on assets, such as the stock market, will be able to withstand the impact of heightened interest rates and the Federal Reserve’s monetary policy aimed at cooling economic growth.
One of the primary concerns related to the recent turmoil in financial markets is the increase in interest rates. As rates rise, the prices of existing bonds fall, leading to what is known as interest rate risk or duration. This risk affects not only individuals and companies but also countries and banks.
The Dow Jones Industrial Index has experienced a significant drop of 6.6% in September alone. Furthermore, the yield on the U.S. 10-year bonds reached 4.7%, the highest level since August 2007. This surge in yields indicates that investors are becoming more hesitant to hold long-term bonds, including those issued by the government.
Banks, which rely on short-term borrowing and often hold Treasurys as reserve assets, are especially vulnerable in this environment. When Treasurys lose value, banks may struggle to meet withdrawal requests. This can force them to sell Treasurys and other assets, pushing them dangerously close to insolvency. The collapse of banks like Silicon Valley Bank, First Republic Bank, and Signature Bank serves as a warning of the potential financial system instability.
Emergency mechanisms, such as the Federal Reserve’s loan programs, can provide some relief to banks by allowing them to use impaired Treasurys as collateral. However, these measures do not eliminate the losses. Banks are increasingly offloading their holdings to private credit and hedge funds, which could further raise yields and amplify losses in the fixed-income markets if the debt ceiling is increased.
As long as interest rates remain high, the risk of financial instability continues to grow. This may prompt the Federal Reserve to support the financial system using emergency credit lines. In this context, scarce assets like Bitcoin could benefit from the increasing inflation and the deteriorating profile of the Federal Reserve’s balance sheet.
Timing such an event is difficult, and it is uncertain what would happen if larger banks consolidate the financial system or if the Federal Reserve guarantees liquidity for troubled financial institutions. However, it is difficult to envision a scenario where Bitcoin would be negatively impacted in those circumstances.
Overall, the recent turbulence in the U.S. economy and the rise in interest rates have raised concerns about the stability of the financial system. While the exact consequences are hard to predict, it is clear that investors and analysts are closely watching the developments and considering the potential impact on various assets, including Bitcoin.
