Japanese Market Sees Worst Losses Since 1987, Traders Blame Carry Trade for Crypto Crash

What a week —and it’s only Tuesday.

Global markets are crashing, tech valuations are plunging, and the crypto market is down to US$1.9 trillion for the first time in six months… and a lot has to do with an unexpected player.

Ethereum (ETH) and Solana (SOL), two of the most popular cryptocurrencies besides Bitcoin, have decreased 26% and 28% in the last seven days, respectively. They are currently priced at US$2.4K (AU$3.6K) and US$131.8 (AU$202). BNB is also down 19% in the weekly chart.

All in all, if you click on the homepage of any data aggregator, you’ll encounter a sea full of painful red charts. But if you don’t have the stomach to visit one of these sites right now— fear not, here’s a chart for you:

Bitcoin saw a sharp decline shortly after reaching a multi-week high, nearing the US$70K (AU$107K) barrier by the beginning of last week. It started to lose momentum by mid-week, dropping to US$66K (AU$101.34K). 

By Friday, the coin kept falling, likely due to growing economic uncertainty in the US and other countries. 

Related: Crypto Market Turmoil: Heavy Losses Across the Board, Analysts Weigh In

Many factors are at play —rising tension in the Middle East, lower tech valuations, Japan’s recent stock market crash, etc.

Impact of Japanese Stock Crash and Global Market Repercussions

What happened in Japan was that its stock market crashed due to a small monetary policy change that affected global markets. On August 5, 2024, the Nikkei 225 index dropped by over 12%, its most significant one-day drop since 1987. 

The key factors behind this crash are the uncertainty surrounding the US economy (which may be in worse shape than had been expected) and changes in Japan’s monetary policy.

So, the US factor can be boiled down to:

• Lacklustre employment data (only 114,000 jobs added in July, far below the market expectation of 175,000).
• The US jobs data fallout triggered fears of a looming recession impacting several sectors, including IT.
• Consequently, investors have rushed to the exit by panic-selling their positions in the market.

Meanwhile, Japan’s policy changes were the final blow that exacerbated the market downturn: the Bank of Japan added a 25-basis point interest rate hike and reduced bond purchases. It doesn’t seem like much, but the problem comes down to carry trades.

In a nutshell, carry trades refer to a trading strategy where you borrow money in a currency with a low interest rate and use it to buy a higher-yielding currency or asset, profiting from the interest rate differential. It works similarly to arbitrage trading in crypto, as both aim to exploit pricing inefficiencies in different markets.

Related: US$801 Million Liquidated as BTC Dips Below US$55K, SOL Drops 30%

So, what’s the problem? Well, the policy changes caused the Yen to appreciate against the US dollar, signalling a potential shift towards a more normalised monetary policy in the country. 

As the yen strengthened, traders were compelled to unwind their carry trades, leading to substantial asset sell-offs and reconversions into yen. This mass liquidation in Japanese equities triggered significant shockwaves across global financial markets.

But take it from John Wu, an investor at Asylum Ventures, who shared a thread on X detailing the event:

An already-weak Yen was making it hard for Japanese to buy foreign goods–a very tough spot to be in for a resource-poor country that imports most of its goods. So in order to combat inflation, the BOJ raised rates. Recall that interest rates are the price of borrowing money, so if you want less money in circulation, you raise the price of creating money.

John Wu