Market Confidence Could Quickly Crumble, BIS Warns Indebted Nations

BIS tower building (BIS)

• Heavily indebted nations face the risk of a sudden loss of market confidence, BIS warned Sunday.
• The umbrella body for central banks cautioned against premature easing of monetary policy.

The Bank of International Settlements (BIS) warned heavily indebted nations on Sunday of a sudden loss of market confidence, validating the long-standing concern in the crypto market.

"Though financial market pricing points to only a small likelihood of public finance stress at present, confidence could quickly crumble if economic momentum weakens and an urgent need for public spending arises on both structural and cyclical fronts," the BIS said in an annual report published Sunday. "Government bond markets would be hit first, but the strains could spread more broadly, as they have in the past."

The BIS did not single out any nation in particular but cautioned advanced economies from running fiscal deficits larger than 1% of the gross domestic product (GDP) this year, down from 1.6% in 2023. The warning could not have been more timely as several nations, including the U.S., go to polls this year, where by governments typically boost spending to garner voter support.

Per some crypto pundits, both bitcoin and gold have been pricing a fiscal crisis in the U.S. and other advanced nations. This year, the so-called zero-yield assets have rallied 48% and 13%, respectively, supposedly on haven demand. While crypto propounders consider BTC an anti-thesis to fiat malaise, the cryptocurrency has tended to drop in line with other risk assets during times of stress.

Public debt as a ratio to GDP has soared worldwide since 2020, a direct result of the coronavirus pandemic that compelled governments to increase spending significantly while facing dwindling revenues. Concurrent rapid rate hikes by central banks added to the fiscal burden. At the end of 2023, the U.S. debt-to-GDP ratio was 123%, indicating a larger total debt than the country's economic output.

The consensus in the crypto market is that mounting debt concerns will force the Fed and other central banks to cut rates, spurring more investor inflows into alternative assets like bitcoin. The CME's FedWatch tool shows traders expect the Fed to cut rates twice this year, by 25 basis points each time.

The BIS, however, has urged central banks to set a "high bar for policy easing."

"A premature easing could reignite inflationary pressures and force a costly policy reversal – all the costlier because credibility would be undermined. Indeed, risks of de-anchored inflation expectations have not gone away, as pressure points remain," the BIS said.

The BIS added that fiscal consolidation will ultimately lessen the need to keep interest rates elevated.

"For fiscal policy, consolidation is an absolute priority. In the near term, this would help relieve pressure on inflation and lessen the need to keep interest rates high, in turn helping to preserve financial stability," the BIS noted.