Here’s an ELI5 on How Japan Sent Global Markets Tumbling
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0.25% – just a blip in crypto terms, but enough to cause a domino effect that’s rippling and causing havoc across global markets.
So, what exactly is happening? The Bank of Japan made the surprise decision to raise interest by 0.25% on July 31. It was the country’s second departure from zero since 2007, sending financial markets into turmoil last Friday, with assets selling off today as if it was another Black Monday.
Japan’s Nikkei 225 stock index is experiencing its worst day since 1987, while the Nasdaq lost 1,000 points for the first time in history, and Bitcoin briefly dropped below $50,000, the lowest since February 2024. Meanwhile the Magnificent Seven, as the top seven technology companies are sometimes referred to, and which include Apple, Meta, Microsoft, NVIDIA, Amazon, Google, and Tesla, have collectively lost more than $750 billion.
Greg Magadini, Director of Derivatives for Amberdata, said he has been following the economic situation in Japan for nearly two decades, and said what the world is witnessing is a “countertrade move.”
A move so volatile, he added, has 1 in 5,000 odds.
A Bet On Japan’s Zero-Interest Rate
Japan’s situation involves carry trades and leveraged unwinding.
A carry trade involves borrowing and selling one thing, then taking that cash and buying something else in hopes of earning more from the asset purchase than it costs to borrow the other one. The strategy works if currency values don’t change much–which is exactly what has happened in this case.
Traders will usually purchase low-interest currency to then pick up high-yield instruments elsewhere, a practice that had become increasingly popular over the years with the Yen having such low interest rates.
With interest rates at zero, investors could borrow Yen at no cost, use it to purchase dollars to then purchase assets that would offer a higher yield , or directly buy financial instruments.
Analysts estimate portfolios held around $4 trillion of JPY carry trades.
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However, after the BoJ hiked rates, the Yen strengthened because investors can receive yield by holding the currency. This is what’s bringing turmoil to the markets.
Investors, now burdened with a stronger Yen, are encountering a twofold problem: higher interest payments and FOREX losses.
“Traders facing big losses and margin calls are selling their US stocks to raise USD, converting back to JPY and paying back their loans,” wrote professional stock trader Adam Khoo, which could lead to more selling pressure on U.S. stocks and even more decline in the short term.
Over the past weeks, investors borrowing Yen now owe 10% more in USD terms, which early stage crypto investor Jonathan Wu called a “double whammy” since loans outstanding are higher for investors, as are interest rates they have to pay.
The result is the aforementioned leveraged unwinding. Traders sell their assets to rebuy a more expensive Yen to pay for their losses, which in turn leads to an even stronger Yen.
According to Wu, the bet from investors was that interest rates would stay at 0 forever, prompting the pair USD/JPY to skyrocket, which would make the Yen worthless, and that BOJ was willing to enact ever more pain on the Japanese consumer.
The JPY/USD pair is up 3.5% to $144, the highest level its been since January.
Not Just Japan
The sell-off, though triggered by Japan, was amplified due to generalized uncertainty around the world.
“Japan is the spark, but there’s riots in the U.K., a potential war in the Middle East, uncertainty in the elections in the U.S., that are kindling for the fire,” said Mandini.
Also, Artificial Intelligence (AI) stocks have been receding, giving him “dot com bubble” vibes.
Khoo agrees with Mandini. He said that the escalation of conflict in the Middle East along with U.S. political tension is only “adding to the fear and panic.”
Investors who are looking for when the sell off won’t get a straightforward answer. Mandini said this should be a short-lived crisis, highlighting that these level of volatility had such low odds of happening in the first place.
Wu disagrees. If investors were indeed betting on zero-interest rates forever, then “we might not even be near the end of forced selling.”
Other analysts also consider the unwinding a “global margin call.” Michael Gayed, mutual fund portfolio manager said that we could be facing a crisis similar to the subprime crunch that triggered the Global Financial Crisis of 2008.
Opportunity
Both Khoo and Mandini agree on something: This is a great buying opportunity.
“As an investor, this is great news because this type of short term crisis and panic is what gives me the opportunity to scoop up high quality US stocks at bigger and bigger discounts,” wrote Khoo. “Take advantage of temporary mis-pricing caused by the short term crisis, he added, “This is how we get richer.”
For Mandini, this is also a great moment to pick up stocks on the cheap, with buying opportunities presenting themselves across markets. He didn’t hide his bullishness for Bitcoin either, calling it the “fundamental footing” as an escape valve to Japan’s macro troubles.
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