Chart of the Week
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The Widowmaker trade became famous in the 1990s and 2000s. It was a bet on the price of Japanese Government Bonds (JGB) going down. Given the Japanese government's ever growing debt levels, many traders assumed that the Bank of Japan would not be able to maintain 0%, or even negative interest rates, permanently. Yet, anyone who bet against JGBs lost for over three decades running, hence the name 'Widowmaker' emerged for this trade. If you cannot fight it, embrace it, became the policy for most traders.
But last week, the tables finally turned. When the Bank of Japan announced a surprise rate increase to 0.25%, markets panicked. On Monday, the Japanese stock index Nikkei, crashed over 10%, dragging all other markets including Crypto with it. Within hours, Bitcoin dropped from a price of $60k all the way down to $49k at its lowest point. Billions in leveraged positions of traders were liquidated both in crypto as well as in stocks. Ethereum recorded its worst single-day drop since May 2021. In Crypto alone, over 200,000 traders were liquidated across exchanges in a 24 hour period.
How did a relatively small rate increase in Japan cause such havoc? First of all, it followed on the back of disappointing US economic data. Traders that had hoped the Federal Reserve would announce rate cuts were disappointed. Also, the hype for AI and tech stocks has visibly calmed. But the true importance of the Japanese decision on global markets was that it dismantled one of the major international financial arbitrage opportunities known as a 'carry trade'.
Banks and funds borrowed cheaply in Japanese YEN, swapped YEN to USD or other currencies and bought better performing assets such as tech stocks or Bitcoin. As stock prices went down and the cost of the borrowing up, market participants quickly had to unwind large positions to reduce their exposure to increased borrowing costs against their YEN positions. This is the Traditional Finance version of what crypto experienced in the spring and summer of 2022, when Luna/Terra, Three Arrow Capital and lending platforms such as Celsius all blew up.
The long-awaited breakout to the downside finally happened. When Bitcoin's parabolic rise earlier in the year had run out of steam, its price setup inevitably became vulnerable to surprise events. The good news is that the Japanese carry trade unwounded quickly. According to JPMorgan, around three-quarters have been removed. Both the Federal Reserve and the Bank of Japan have reassured markets. The rebound has been surprisingly strong. As of the end of the week, Bitcoin recouped the entirety of its losses and traded once again above the $60k price mark.
The 'good' story here is the underlying strength that Bitcoin demonstrated. Meanwhile, the rest of the crypto market remains in wait mode. Ethereum is still substantially below the $3k mark. Many risks remain on the horizon. Further US economic weakness could push markets down further. On the other hand, the expectation that the Federal Reserve will finally begin reversing rate hikes is the hope for many market participants. Short-term pain might still await but markets are hoping for a more promising end to the year.
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