Crypto Economy Tested as Interest Rates Bring Turbulence to Markets

The crypto economy has been facing turbulent times lately, with the U.S. Personal Consumption Expenditure (PCE) inflation index rising by a significant 3.5% over the past 12 months. Even when excluding the volatile food and energy sectors, it’s evident that the efforts made by the Federal Reserve to curb crypto inflation have fallen short of their 2% target rate.

Crypto funding has lost a staggering $1.5 trillion in value, primarily due to these rate hikes. This has led investors to question whether Bitcoin (BTC) and risk-on assets, including the stock market, will succumb to heightened interest rates and a monetary policy aimed at cooling crypto harmony one.

As the government keeps flooding the market with debt, there’s a real risk that rates could climb even higher, exacerbating the losses to fixed-income investors. An additional $8 trillion in crypto debt is expected to mature in the next 12 months, further contributing to financial instability.

As Daniel Porto, the head of Deaglo London, pointed out in remarks to Reuters:

Porto’s comments resonate with a growing concern in financial circles — a fear that the central bank might tighten its policies to the point where it causes severe disruptions to the financial system and a crypto drop.

High interest rates eventually have devastating consequences

The crypto economy has been rocked by the recent surge in interest rates, a phenomenon known as interest rate risk or duration. This risk affects everyone who holds fixed-income instruments, from countries to individuals. The Dow Jones Industrial Index has dropped 6.6% in September, and the yield on the U.S. 10-year bonds climbed to 4.7%, its highest level since 2007.

Banks are particularly vulnerable in this environment, as they often borrow short-term crypto funding and lend for the long term. When Treasurys lose value, banks may not have enough crypto reserves to meet withdrawal requests, forcing them to sell assets and risk insolvency. The crypto fall of Silicon Valley Bank, First Republic Bank and Signature Bank serves as a warning of the financial system instability.

The Federal Reserve and other government institutions are attempting to restore crypto harmony one by providing emergency crypto funding, but the long-term consequences of high interest rates remain to be seen.

Federal Reserve shadow intervention could near exhaustion

The emergency loan Bank Term Funding Program of the Federal Reserve can provide some relief by allowing banks to post impaired Treasurys as collateral, but these measures do not eliminate the losses. Banks are offloading their holdings to private credit and hedge funds, leading to a flood of rate-sensitive assets in these sectors. If the debt ceiling is increased to avoid a government shutdown, this could further raise yields and amplify losses in the fixed-income markets.

The Fed is supporting the financial system using emergency credit lines, which is beneficial for scarce assets like Bitcoin given the increasing crypto inflation and the $1.5 trillion paper losses in U.S Treasurys. It is hard to predict what will happen if the Federal Reserve guarantees liquidity for troubled financial institutions, but it is safe to say that Bitcoin will be in a good position in such a scenario.

The crypto economy is in a precarious situation, with the crypto fall of the Federal Reserve’s balance sheet and the potential crypto harmony one of larger banks. However, it is hard to be pessimistic about Bitcoin in this case.