Ray Dalio warns that the US might experience a “debt-induced heart attack” in about three years due to recent spending sprees. He believes this could occur “give or take a year or two,” raising alarms about the nation’s financial stability. The mismatch between the supply and demand for US debt could force the Federal Reserve into a tough spot. It might need to let interest rates rise, which could lead to a debt-default crisis, or print money to buy unwanted bonds. Both choices could hurt the US dollar and raise doubts about its fiscal reliability.

Long-Term Warning Becomes Short-Term Reality

The long-term warning about a US debt crisis is now becoming an immediate concern. With national debt exceeding $39 trillion, stress is mounting in the financial system. This pushes us to brace for the Federal Reserve’s tough decision: raise rates and risk defaults or print money and cause inflation, both harmful to the dollar. For those trading derivatives, this environment means we can expect increased volatility in interest rates and currency markets in the coming weeks. Looking back at the instability in the UK gilt market in 2022 shows how fast confidence can crumble when fiscal policy is questioned. Using options to hedge against sharp market swings, like VIX calls or puts on long-duration Treasury ETFs such as TLT, appears to be a wise strategy. The US dollar is particularly vulnerable. It could weaken whether the Fed raises rates in a slowing economy or has to print money. The Dollar Index (DXY) has already shown considerable weakness this year, falling below the 100 level multiple times. This makes strategies like buying puts on the dollar or call options on safe-haven assets like gold and the Swiss franc more appealing.

Weakening Demand for US Debt

Signs of weakening demand for US debt are starting to show in government auctions. Last month’s sale of 10-year notes saw a bid-to-cover ratio of just 2.2, a historically low number that indicates investors are reluctant to take on the large supply of new bonds. This could lead to higher long-term interest rates to attract buyers, posing even more risks to the economy. Create your live VT Markets account and start trading now.

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