Last Monday, global financial markets experienced a sharp selloff, driven largely by the unwinding of the Japanese yen carry trade. This event sent shockwaves through equities and digital assets, leading to significant losses across various markets.
The S&P Global Broad Market Index, which tracks over 14,000 stocks worldwide, suffered a 3.3% drop—the worst trading day in more than two years.
The Tokyo Stock Price Index (TOPIX) plummeted 20% in its most significant three-day loss ever, while the Bloomberg Galaxy Crypto Index saw a steep decline of 17.5%.
Key Market Reactions
- S&P Global Broad Market Index: Fell 3.3%, marking its worst performance in over two years.
- Tokyo Stock Price Index (TOPIX): Experienced a 20% drop, the largest three-day decline in its history.
- Bloomberg Galaxy Crypto Index: Declined by 17.5%, reflecting the broader selloff in digital assets.
Understanding the Carry Trade
For those unfamiliar with the concept, carry trades involve borrowing in a low-interest-rate currency, such as the Japanese yen, and investing the borrowed funds in higher-yielding assets in other markets.
I’m not sure I am totally understanding the logic of this trade. So you are selling $32 strikes right now and are willing to cover assignment by purchasing at market if necessary? Why carry the LEAP? Just sell the naked calls if your options level supports that and if you…
— The Expedition Trader (@TheExpedTrader) August 13, 2024
This strategy has been particularly lucrative given Japan’s longstanding policy of near-zero interest rates. However, recent developments have disrupted this profitable trade.
The Impact of BOJ’s Rate Hike
The Bank of Japan (BOJ) recently implemented a rate hike, which caused a rapid appreciation of the yen against the U.S. dollar.
This sudden strengthening of the yen created significant pressure on Japan’s export-driven economy, as a stronger yen makes Japanese goods less competitive internationally.
The unwinding of the yen carry trade was a direct consequence of this rate hike, as investors rushed to close their positions, triggering widespread market instability.
Historical Parallels
The yen’s recent appreciation brings to mind previous financial crises, such as the 1998 Long-Term Capital Management (LTCM) collapse and the 2007 subprime mortgage crisis. In both instances, the yen appreciated significantly—by about 20% from its low—echoing its recent behaviour.
As of early August, the yen had already gained over 10% against the U.S. dollar, signaling that the current unwinding might still have further to go.
BOJ’s Response and Market Outlook
In the aftermath of the selloff, the BOJ softened its stance, with Deputy Governor Shinichi Uchida pledging to refrain from further rate hikes amid the ongoing market turbulence.
Indeed, as I’ve posted yesterday, most probably they’ve (BOJ) have done some kind of intervention on Monday after Japanese markets close to calm down the market, and the next day they’ve reiterated that verbaly. pic.twitter.com/IRIz2kmssh
— 𝘎𝘢𝘵𝘪𝘵𝘰 𝘚𝘪𝘯𝘪𝘦𝘴𝘵𝘳𝘰 (@Katzelebaroiges) August 7, 2024
While this may provide short-term relief, the broader implications of the yen’s rise and the carry trade unwinding are likely to continue influencing global markets.
JPMorgan’s August 9 report suggests that the unwinding is only about halfway complete, signaling potential further disruptions.
Bitcoin’s Volatility vs. Gold’s Stability
As global equities plunged, Bitcoin’s performance drew significant attention. The leading cryptocurrency dropped as much as 17% on Monday, briefly falling below $50,000 for the first time since February, before recovering some losses and ending the day down 8%.
This contrasted sharply with gold, which only fell slightly over 1% during the same period.
- Bitcoin’s Performance: Fell 17% intraday, ending 8% down.
- Gold’s Performance: Declined just over 1%.
The selloff highlighted a critical observation: Despite being referred to as “digital gold,” Bitcoin has yet to consistently demonstrate the stability of traditional gold during periods of market stress.
Analysis by Citi’s David Glass and others indicates that Bitcoin behaves more like a risk-on asset rather than a safe haven, offering higher potential returns during market rallies but with greater risk during downturns.
Investment Takeaways
For conservative investors, maintaining a 10% portfolio allocation in gold and gold mining stocks remains a prudent strategy.
Meanwhile, Bitcoin and other digital assets may appeal more to those with a longer time horizon or a higher risk tolerance, given their potential for substantial gains during market rallies.
However, the recent events serve as a reminder of the inherent volatility and risks associated with digital assets.
