Bitcoin’s inflation hedging theory has been tested as interest rates rise ScrgruppEn

The US economy has been facing turbulent times recently, with US personal consumer spending inflation rising by a whopping 3.5% over the past 12 months. Even when excluding the volatile food and energy sectors, it is clear that the US Federal Reserve’s efforts to curb inflation have not reached the target rate of 2%.

US Treasury bonds have lost a staggering $1.5 trillion in value, primarily due to rising interest rates. This has led investors to question whether Bitcoin (BTC) and high-risk assets, including the stock market, will succumb to higher interest rates and monetary policy aimed at cooling economic growth.

Theoretical losses for holders of US Treasury bonds in US dollars. source: @JoeConsorti

As the US Treasury continues to flood the market with debt, there is a real risk that interest rates will rise to even higher levels, exacerbating losses for fixed-income investors. An additional $8 trillion in government debt is expected to come due in the next 12 months, contributing to further financial instability.

As noted by Daniel Porto, President of Diglo London comments To Reuters:

“(The Fed) will play an inflation-led game, but the real question is can we maintain this path without doing too much damage?”

Porto’s comments resonate with a growing concern in financial circles: the fear that the central bank will tighten its policies to the point of causing severe disruptions in the financial system.

High interest rates ultimately lead to disastrous consequences

One of the main factors behind the recent turmoil in financial markets is rising interest rates. As interest 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 holding fixed income instruments.

The Dow Jones Industrial Average saw a 6.6% decline in September alone. In addition, the yield on US 10-year bonds rose to 4.7% on September 28, reaching its highest level since August 2007. This rise in yields indicates that investors are becoming increasingly reluctant to take on the risks of holding long bonds. terms, even those issued by the government itself.

Banks, which typically borrow short-term instruments and lend long-term, are particularly vulnerable in this environment. They rely on deposits and often hold Treasury bonds as reserve assets.

When Treasuries lose value, banks may find themselves short of funds to meet withdrawal requests. This forces it to sell US Treasuries and other assets, pushing it into a dangerous level of default and requiring a bailout by institutions such as the Federal Deposit Insurance Corporation or larger banks. The collapse of Silicon Valley Bank (SVB), First Republic Bank, and Signature Bank was a warning of the instability of the financial system.

The Fed’s shadow intervention may be on the verge of exhaustion

While emergency mechanisms, such as the US Federal Reserve’s emergency loan program, can provide some relief by allowing banks to put up distressed Treasuries as collateral, these measures do not magically make losses disappear.

Banks are increasingly offloading their holdings to private credit and hedge funds, flooding these sectors with interest rate-sensitive assets. This trend is expected to worsen if the debt ceiling is increased to avoid a government shutdown, increasing returns and amplifying losses in fixed income markets.

As long as interest rates remain high, the risk of financial instability increases, prompting the Federal Reserve to shore up the financial system with emergency credit lines. This is extremely beneficial for scarce assets like Bitcoin, given the rising inflation and deteriorating situation on the Federal Reserve’s balance sheet as measured by the $1.5 trillion in paper losses on US Treasuries.

The timing of this event is almost impossible, let alone what would happen if larger banks consolidated the financial system or if the Fed acted to ensure liquidity for distressed financial institutions. However, there is no scenario in which one can be pessimistic about Bitcoin under these circumstances.

This article is for general information purposes and is not intended and should not be taken as legal or investment advice. The views, thoughts and opinions expressed herein are those of the author alone and do not necessarily reflect or represent the views and opinions of Cointelegraph.

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