Yen Carry Trade Behind Global Stock and Crypto Market Meltdown

Global financial and cryptocurrency markets experienced one of their most severe downturns on August 5th, with the Bank of Japan’s policies being scrutinized as a potential cause. For months, the Bank of Japan (BoJ) has supported low-interest-rate loans, which many observers believe contributed to the current financial turmoil. 

There is optimism that the worst of the meltdown might be over and that cryptocurrencies may recover quickly. Many experts suggest that the rising costs of yen-denominated loans have significantly contributed to the financial crash. Kobeissi Letter, a prominent global market commentary platform, identified the yen carry trade as a primary factor behind the market chaos. 

The Bank of Japan’s decision to raise interest rates to 0.25% from 0.1% has strengthened the yen, disrupting the yen carry trade. This rate hike, approved in a 7-2 vote, marks only the second increase since 2007 and signals the end of Japan’s hostile interest rate policy.  

BoJ’s role in global market decline  

Before the interest rate increase, investors borrowed yen at meagre rates to leverage their investments in higher-yielding assets in other markets. Both retail and institutional investors were worried about the yen’s depreciation against other currencies. According to the Kobeissi Letter, investors borrowed yen and converted it into stronger currencies like the US dollar, effectively getting an almost free margin call.  

In the cryptocurrency market, short-term trades are often driven by institutional traders who rely heavily on leverage to increase purchasing power and boost gains. Japan recently became an attractive market for these investors due to the availability of cheap loans. A report from ING Bank highlighted that yen-denominated loans to foreign borrowers reached $2 trillion, the highest level in two years.  

Yen’s strength against the US dollar 

The USD/JPY exchange rate recently dropped from a high of 161 in mid-July to 145, making yen-denominated loans more expensive. July also witnessed a sharp increase in US unemployment numbers, further affecting market dynamics. As a result, traders initiated billions of dollars worth of liquidations due to margin calls or as a precaution to mitigate risk exposure. The sell-off led to a dramatic decline in global markets, with the S&P 500 index dropping by 5%, significantly impacting US markets.  

During an interview with CNBC, American investor Kyle Bass emphasized that Japanese retail savers had invested in dollar assets to protect against the yen’s decreasing purchasing power. The market sell-off caused significant declines in major cryptocurrencies like Bitcoin and Ethereum.  

Impact on Bitcoin and Ethereum  

The cryptocurrency market was not immune to the turmoil, as Bitcoin and Ethereum experienced significant drops within 24 hours. Bitcoin fell by 18%, while Ethereum saw a 26% decline. Bitcoin had surpassed the $70,000 mark in July before plunging below $49,000 on August 5th. Ethereum also experienced a similar trajectory, reaching $3,500 in July before dropping to $2,100.  

The market meltdown has highlighted the interconnectedness of global financial systems and the impact of monetary policies across different asset classes. Observers will closely monitor developments in Japan and other key markets in the coming weeks to assess the potential for recovery and stability.

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