Take A Breather From The Doom Porn: Here Is Why The Selloff In Bitcoin Is Now Overextended

This is not investment advice. The author has no position in any of the stocks mentioned. Wccftech.com has a disclosure and ethics policy.

Fear, panic, liquidations, margin calls. These are some of the choice words that can be used to describe the ongoing carnage in global equities and cryptocurrencies, including Bitcoin. Yet, akin to a toddler prone to throwing tantrums at the slightest inconvenience, the market has a proclivity to overreact to given stimuli. A case in point: the excesses of the recent AI bubble and the ongoing Fed- and Yen carry trade-driven global margin call.

Records Are Now Being Broken Left, Right, And Center, And Bitcoin Finds Itself In The Middle Of This Maelstrom

We noted yesterday how the activation of the so-called Sahm Rule conditions in the US triggered weakness in Bitcoin and equity futures on the back of growing odds of a recession in the world's largest economy.

It seems unintuitive that a small 25 basis point interest rate hike in Japan would spike all risk assets, including tonight's -20% $ETH candle.

But you need to understand the way the carry trade works:

It's a leveraged unwinding.

— jonathan(love)wu (@jonwu_) August 5, 2024

Well, today, Asia got its first chance to react to Friday's highly disruptive Non-Farm Payroll report in the US. And that reaction morphed into a full-blown implosion of the so-called Yen-based carry trade. The above X post provides an excellent primer on the mechanics of this carry trade.

Basically, for years, sophisticated investors took advantage of Japan's extremely low interest rates to borrow in Yen and then invest the proceeds in higher yielding assets in the US and other countries. Given the Yen's shallow depreciation trend for decades - a requirement of sorts to keep its export-based economy competitive - such investors leveraged this macro trend to turbo-charge gains.

Of course, this paradigm ended abruptly last week when the Bank of Japan (BoJ) adopted a hawkish stance and materially increased (by Japanese standards) its benchmark interest rate to combat import-driven inflation on the back of an excessively weakening Yen. This policy change made a lot of carry trades unprofitable, prompting some unwinding actions.

Then came Friday's NFP report, which increased investors' conviction regarding the odds of a substantial economic weakening in the US and precipitated further turmoil in assets that were bought by leveraging the Yen-based carry. It is generally believed that these carry trades played an important role in inflating the AI bubble by propelling NVIDIA and other high-flying names to the proverbial stratosphere. These trades also likely contributed to Bitcoin's extraordinary strength earlier this year. Do note that as of November 2023, the Yen-based carry trades were worth a whopping $20 trillion!

This brings us to today's market carnage that spurred the Japanese TOPIX index to close down 12 percent, marking it steepest losses since the Black Monday-induced carnage of 1987. Almost all of Asia closed in the red today, with hefty selling witnessed in South Korea and the tech-heavy Taiwan.

VIX in context: 3rd biggest crisis in history. pic.twitter.com/GLVGA7H9oQ

— zerohedge (@zerohedge) August 5, 2024

In the US, the VIX - the market's fear gauge of sorts - just recorded its third-highest jump on record. The Nasdaq 100 index is approaching correction territory. The Magnificent 7 grouping of high-flying stocks are collectively down at least a trillion dollars, with NVIDIA alone down 12 percent.

Meanwhile, Bitcoin fell below the $50,000 price level for the first time since February 2024. And Robinhood has halted its 24-hour trading facility due to extensive market volatility. Even Gold is down around 2 percent.

Yield Curve univerts pic.twitter.com/PEXi1fvsZb

— James Van Straten (@jvs_btc) August 5, 2024

Finally, we note that the 2 yr - 10 yr yield curve has finally uninverted, which is one of the strongest historical signals of an oncoming recession.

Calm Down: Some Of These Moves Do Not Have A Grounding In Fundamentals

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This brings us to the crux of the matter. MicroStrategy is often considered a levered bet on Bitcoin itself. Typically, the stock posts 2x Bitcoin's losses during times of turmoil. At the moment, Bitcoin is down ~12 percent while MicroStrategy shares are down ~18 percent. If we assume that MicroStrategy is correctly pricing Bitcoin's weakness, the world's largest cryptocurrency should only be down ~9 percent.

On the macroeconomic front, we note that Friday's triggering of the Sahm Rule conditions was skewed by the lingering effects of Hurricane Beryl, which boosted the unemployment rate by 0.2 percent on the account of temporary layoffs.

The Fed is unlikely to announce an emergency rate cut, since nothing has fundamentally changed from an economic standpoint since last week’s FOMC meeting. One can assume Fed Chair Powell knew about Friday’s weak employment number (+114K vs +175K expected) before Wednesday’s… https://t.co/M4ZlyadGwT

— Gary Black (@garyblack00) August 5, 2024

Also, for those insisting that the Federal Reserve committed a policy mistake by not reducing its benchmark interest rate last Wednesday, Future Fund's Gary Black has penned a pertinent note, hammering on the fact that the Fed likely had visibility of Friday's NFP report and that the underlying macroeconomic conditions in the US are nowhere near recessionary.

1/ As pointed out in a Bloomberg article, before today's downturn, there were significant leveraged inflows into tech stocks. Now, many of these investors may face margin calls due to the sharp drop in stock prices. Let's see what that means 🧵 pic.twitter.com/lj61dgHkmQ

— Menthor Q (@MenthorQpro) August 5, 2024

Of course, this analysis does not take into account the disorderly unwinding of Yen-based carry trades that are likely fueling a lot of today's turmoil.

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