Will the downgrade of the US credit rating by Fitch trigger a bull market for Bitcoin?

Will Fitch's US credit rating downgrade initiate a bitcoin bull market?

Author: MARCEL PECHMAN, COINTELEGRAPH; Translation: Song Xue, LianGuai

On August 1st, a major event occurred in the financial world: Fitch, a well-known credit rating agency, downgraded the credit rating of the US government from AAA to AA+. This downgrade indicates that people’s confidence in the US government’s ability to fulfill its fiscal responsibilities has weakened.

The rating downgrade prompted investors to take a cautious stance, leading many to withdraw funds from stocks, silver, oil, and long-term bonds, among other assets. Instead, they prefer cash and short-term investments, which are considered safer choices during uncertain periods.

Standard & Poor’s 500 index futures (blue), WTI oil futures (green), US 20-year Treasury bonds (yellow), silver coins (orange). Source: TradingView

From the above chart, it is evident that Fitch’s decision to downgrade the US government’s credit rating has had a widespread impact, affecting commodities, fixed income, and stocks. This has implications for various financial institutions and portfolios, including Bitcoin.

Traders are now considering whether Bitcoin’s digital scarcity and resistance to censorship can provide shelter from the widespread “flight to safety” triggered by the deteriorating credit rating of the world’s largest economy.

Limited impact on the market

A report by Moody’s in May hinted at a potential domino effect of the US credit downgrade. Downgrading the national debt could lead to further downgrades in the financial industry’s ratings. It is worth noting that only Fitch and Standard & Poor’s have rated the US. While the debt rating is AA+, Moody’s still maintains an AAA rating with a stable outlook.

Interestingly, the cost of credit default swaps for US sovereign debt, as indicated by the credit default swap market, has remained relatively stable after the downgrade. This is surprising given the magnitude of the news.

Value of US 5-year sovereign credit default swaps. Data source: World Government Bonds

This financial instrument can hedge against the risk of default on debt. It functions similar to an insurance policy, where investors pay a premium to receive compensation if the debt issuer (in this case, the US government) defaults.

This stability indicates that investors are not concerned about the direct impact of the rating downgrade. One possible reason is that US Treasury bonds are considered one of the safest investments globally because they have the backing of the US government. The issuer guarantees repayment of the debt, including interest, on specified maturity dates.

12-hour chart of the US 5-year Treasury yield. Source: TradingView

Please note that, given the continuous rise in the 5-year Treasury yield over the past two weeks, the recent daily yield volatility seems less significant. This may be related to weakened investor confidence in US debt management, which has boosted demand for higher yields.

In addition to the trend in US Treasury yields, a decline in the US Dollar Index (DXY), which measures the value of the US dollar against other currencies, could also pose challenges. If this leads to a decrease in confidence in traditional assets, investors may seek alternative stores of value, potentially enhancing the attractiveness of Bitcoin.

US Dollar Index. Source: TradingView

Over the past two weeks, the US Dollar Index has risen from 99.50 to 102.60, indicating a potential shift in investor sentiment. They may abandon Treasury bonds, stocks, and commodities in favor of seeking refuge in cash, highlighting the appeal of the US dollar in uncertain times.

Near-term outlook for Bitcoin price is pessimistic

Based on the US Dollar Index, the flexibility of credit default swaps on US Treasury bonds and the strength of the US dollar suggest that investors may have increased their cash holdings in anticipation of market turbulence.

Therefore, Bitcoin may not immediately thrive from the downgrade of the US government’s debt rating. During early market turmoil, the initial flight to liquidity often overlooks the benefits of decentralized assets.

Given Bitcoin’s digital scarcity and fixed supply, it stands out amidst expanding government debt as a valuable asset, while government debt may devalue cash. Consequently, investors may increasingly view Bitcoin as a safe haven and a powerful asset class due to its decentralized nature, which can resist censorship.