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The 3 Reasons Behind Bitcoin-Holder El Salvador’s Deteriorating Creditworthiness

The 3 Reasons Behind Bitcoin-Holder El Salvador’s Deteriorating Creditworthiness. When El Salvador adopted bitcoin as legal tender in September. the move received a rapturous reception from the crypto community. with many predicting a change in the debt-ridden nation’s fortunes.

Five months later, the perception of the country’s sovereign credit is four times worse than it was.

The 3 Reasons Behind Bitcoin-Holder El Salvador's Deteriorating Creditworthiness

Federal Reserve’s hawkish turn also appears to have played a role.

Bitcoin’s adoption as legal tender

The five-year CDS almost tripled to $1,100 from $400 after El Salvador’s bitcoin law took effect Sept.

The 3 Reasons Behind Bitcoin-Holder El Salvador's Deteriorating Creditworthiness

The bond was trading at over 78 cents on the dollar, offering a yield of over 35%.

“What they [El Salvador] might have to worry about is whether the IMF will come with a bailout or not because of their BTC adoption,” David Belle, founder of Macrodesiac.com and U.K. growth director at TradingView, told CoinDesk in a WhatsApp chat.

Bitcoin’s price slide

Since mid-November. El Salvador’s five-year CDS has jumped to $1,800. while bitcoin’s price has dropped nearly 40% from record highs near $69,000.

The country’s credit outlook is now exposed to bitcoin’s price gyrations because the nation holds more than 1,300 BTC and plans to issue a $1 billion. 10-year bitcoin bond this year. Bukele has been a consistent dip buyer over the past couple of months in a sign of confidence in the cryptocurrency’s long-term prospects.

“The government’s Bitcoin holdings certainly add to the risk portfolio. ” Jaime Reusche, an analyst at rating agency Moody’s, told Bloomberg on Wednesday. “Trading Bitcoin is quite risky, particularly for a government that has been struggling with liquidity pressures in the past.”

According to Moody’s, the value of El Salvador’s bitcoin holdings has dropped some $10 million. and further purchases would amplify the risk. ByteTree’s Morris foresees a further rise in the CDS if bitcoin’s bear run continues. but expects little respite even if bitcoin strengthens because “El Salvador has lost friends in the IMF.”

Demand for the bitcoin bond could be tepid if the cryptocurrency remains in the clutches of the bears. That’s because the returns offered by the bond are tied to bitcoin’s price.

While Blockstream sees annualized yield on the crypto bond reaching 146% in the 10th year. the performance is conditional on bitcoin rallying to $1 million in the next five years. That’s an aggressive target, given it is currently trading near $41,800.

Selling “a decent amount of Bitcoin bonds could potentially help them with their liquidity pressures,” Moody’s Reusche told Bloomberg. But “unless Bitcoin bonds are very well received and oversubscribed, we are seeing that the probability of the need to restructure their traditional market bonds is increasing.”

High yields on the country’s dollar-denominated debt have already closed the doors to foreign bond markets. “Their 10-year USD bond has collapsed heavily, yielding about 40% now, which is insane for a sovereign bond,” Macrodesiac’s Belle said.

Fed tightening fears

Since November. the Fed has turned decidedly hawkish, signaling three rate hikes for 2022., an end to the asset purchase program in two months, and readiness to shrink its balance sheet. The Fed fund futures have baked in four quarterly rate hikes, and that has a knock-on effect for El Salvador.

“CDS appears to be spiking because of higher interest rates being priced in more and more,” Belle noted. “We’re now expecting FIVE Fed rate hikes this year.”

The debt burdens of El Salvador and other emerging nations with dollar-denominated bonds become more expensive as the Fed tightens. Thus, CDS offering insurance against potential default become costly.

Emerging markets’ sensitivity to Fed tightening is also evident from the recent spike in the JPMorgan emerging market bond spread.

The 3 Reasons Behind Bitcoin-Holder El Salvador's Deteriorating Creditworthiness

UPDATE (Jan. 20, 13:35 UTC): Corrects spelling of “creditworthiness” in headline.

UPDATE (Jan. 20, 13:41 UTC): Corrects spelling of “bitcoin” in headline.

President Bukele’s bitcoin policy and hawkish Fed expectations cloud Salvador’s credit outlook.Read MoreCoinDesk

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