Japan's rate hike pushed markets into a plunge
The financial markets saw quite a drop during Monday, as both the stock and crypto markets came down with a rush. The price of the largest cryptocurrency bitcoin, which was already in a downward trend, fell by about twenty percent in one day, falling below 50,000 dollars.
In smaller tokens, the drops were even bigger, as usual. This was the biggest price drop since November 2022 and the collapse of the crypto exchange FTX.
A similar short-term collapse was also seen in the stock market, with both the US S&P 500 index and the Japanese Nikkei index plummeting.
What caused the sudden crash?
According to our interpretation, it was a matter of several simultaneous factors that all reduced investors' risk appetite, forming a so-called into a perfect storm. One way to describe the accumulation of investor worries could be:
Looking at the monthly level, it has been seen that concerns about the US drifting into recession have grown. Among other things, the development of employment rates has not met more optimistic expectations. Recession has traditionally not been a favorable condition for risky asset classes.
Looking at the weekly level, concerns have been increased by the increase in geopolitical tensions in the Middle East. Increasing risks of conflicts often increase caution in the market, especially when located in an oil-producing region that is central to the global economy.
Looking at the daily level, significant news was received last week when the Bank of Japan announced that it would raise its interest rate. Japan's remarkably low interest rates have brought significant capital flows into the US stock market, as investors have been able to borrow money from Japan at zero interest and invest it in the US stock market. For this so-called "carry trade", rising Japanese interest rates are an unfavorable development, and probably led to the realization of high-yielding investments.
Together, these factors formed a trifecta, the effects of which erupted on Monday as a sharp market decline in all risk-on asset classes. None of these factors in itself can be considered a complete surprise, but what was somewhat surprising was how suddenly and violently the need to reduce risk materialized.
Crypto market in macro turmoil
After understanding the big picture of market events, we can next look at cryptocurrency movements in this context.
First of all, it is good to realize that, in our view, cryptocurrencies started this correction movement from quite high valuation levels. From the middle of July to the beginning of August, we had witnessed a rather atypical situation, where the stock market had already turned into a correction movement, but the crypto market, which normally correlates with it, still hit a new local peak in the last weekend of July.
We cannot name a certain reason for this discrepancy, but we consider it likely that it was related to the annual Bitcoin Conference organized on the last weekend of July, in which guest speaker Donald Trump, profiled as a pro-crypto presidential candidate, was expected to make positive statements about the future of cryptocurrencies and especially Bitcoin after his possible re-election.
Whatever the reason for the temporary decoupling of the stock and crypto markets in the second half of July, as a result, the crypto market appeared to be quite highly valued in relation to, for example, technology stocks at the beginning of August.
For crypto-investor a set up like this should generally be approached with a bit of caution, because overvaluation like this usually has a tendency to correct itself at some point, and combined with the general downward trend of the market, it often means particularly hard price drops for cryptocurrencies.
Considering this initial situation for the price drop, we do not consider the fall of the crypto market to be particularly severe. At the time of writing (Wednesday, August 7, 2024), the total value of the crypto market (excluding the largest stablecoins) in relation to the NDX index is, perhaps somewhat surprisingly, still at the level of the strong market rise of February 2024. Depending on the interpretation, this can be seen as either:
1. As a demonstration of the remarkable resilience of the crypto market
OR
2. As a warning that as the general market decline continues, there is still considerable room for a fall in crypto prices. Lowering of BTC/NDX ratio to, for example, the level of autumn 2023 would mean a decrease of about 40% against the NDX index.
What’s next for crypto?
In this turmoil, the question naturally arises, what should we expect from the crypto market next?
On 7/23/2024, with the bitcoin price around $66,000, we wrote in our previous Pulse newsletter:
"If the central message of our previous newsletter was optimism in the midst of a price drop, this time it is an awakening of caution in the midst of a price rise. Despite the strong price increase of the last few weeks, we see some signs that make us aware that this uptrend might soon come to at least a temporary halt."
For the last few months, in the choppy movement of the crypto market, we think we have managed to predict the turning points of the market relatively well. This is first and more most for the fact that the crypto market has quite obediently followed its typical positive correlation with the EUR/USD currency pair and the inverse correlation with the dollar index (DXY).
After the last few days, we are in a situation where these correlations have turned upside down. Bitcoin has weakened against the dollar, which in turn has, not strengthened, but weakened against the euro.
From the point of view of technical analysis, the situation resembles what was seen a month ago. Back then, EURUSD was in a clear upward trend, but BTCUSD was falling due to momentary one-off selling pressure.
At that time, we encouraged our readers to be optimistic in the midst of the crypto market crash. It seemed pretty clear to us that the market crash was an internal, one-time and transitory event in the crypto market in an otherwise risk asset-friendly macro environment.
At the moment, the situation is a little different. Similar significant negative catalysts have not occurred within the crypto market. Some analysts attribute the market decline to the new US Democratic presidential candidate Kamala Harris' greater chances of victory than the previous candidate Joe Biden, but we don't think this plays a particularly big role in the market turmoil we are seeing now. We could give a little more weight to the significant liquidation sales of the trading company Jump Crypto over the weekend, which put even more pressure on fragile cryptocurrencies due to the macro situation.
However, it seems clear that this time the main reasons for the market decline lie in the macro economy and the exceptional behavior of the JPY/USD currency pair. Therefore, the continuation or reversal of the downward trend will also be decided through these factors. The head of the Bank of Japan, Shinichi Uchida, calmed the markets on Wednesday by stating that the central bank will take into account the development of the investment market in its future interest rate decisions. The stock market has shown a some recovery during Tuesday and Wednesday. An optimist might see that the worst is over.
At the moment, we have to state that the situation is still quite unclear and changes by the day. Probably by the time our next Pulse newsletter is published, the situation will have already become much clearer. A crypto investor should follow both the crypto and the stock market quite closely.
Regarding possible new movements down, the best indicator might be the TradingView ticker OTHERS, which describes the market value of smaller alt-coins. Downward movements often appear first in the price of smaller tokens and only a little later in the price of larger tokens, for example bitcoin, as capital first moves from small tokens to dollars and bitcoin. At the time of writing, the upward momentum of the OTHERS category seems to be fading, which could foreshadow the next downward movement.
We will continue to monitor the situation and return with our analysis in the Pulse newsletter again next week!
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