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In his latest essay “Spirited Away,” Arthur Hayes, the former CEO of BitMEX, dives into the complexities of the global financial markets, with a focus on the impending unwinding of the dollar-yen carry trade and its impact on the crypto market.
Hayes begins by discussing the potential actions of the US Vice President Kamala Harris in response to an impending financial crisis, influenced by her need to secure electoral victory. He predicts, “Harris will instruct Yellen to use the monetary tools available to her to avert a financial crisis,” suggesting an immediate response to stabilize the markets expected “no later than the opening of Asian trading next Monday, August 12th.”
The analysis revolves around the ‘yen carry trade,’ where Japan Inc. borrows yen at low rates to invest in higher-yielding foreign assets. This trade has been massively profitable due to the Bank of Japan’s (BOJ) policies that keep yen liabilities low and asset returns high, facilitated by a weak yen. However, Hayes points out the vulnerabilities of this strategy: “If the BOJ ceases its bond purchases, the unwinding could lead to significant yen appreciation and a corresponding decline in global equity markets.”
Hayes outlines the potential dire consequences of a sudden strengthening of the yen, predicting drastic impacts on global stock markets. He quantifies these impacts, stating, “If the dollar-yen reached 100, a 38% move, the Nasdaq would drop to ~12,600 and the Nikkei to ~25,365,” indicating severe repercussions for global financial stability.
According to the former BitMEX CEO, the full unwind of the dollar-yen carry trade is a question of when, not if. “The question is when the Fed and Treasury will print money to blunt its effects on Pax Americana,” he adds and describes a scenario where the US equity markets could crash into this upcoming Friday. “Then some sort of action over the weekend is probable,” according to Hayes.
He further theorizes on a more long-term scenario: “If the yen starts to weaken again, the crisis is over in the immediate term. The unwind will continue, albeit at a slower pace. I believe the markets will throw another tantrum between September and November as the dollar-yen pair resumes its death march toward 100. There will definitely be a response this time around, as the US presidential election will be weeks or days away.”
How To Trade Crypto In This Environment
Hayes describes the situation as complex due to two conflicting liquidity forces. “Trading this in a crypto fashion is difficult. Two opposing forces influence my crypto positioning,” he states.
First, there is the “Liquidity Positive Force”. This force emerges from the US Treasury’s potential actions, which could inject significant dollar liquidity into the market. Hayes notes, “After a quarter of net restrictive policy, the US Treasury will net inject dollar liquidity because it will issue Treasury bills and possibly deplete the Treasury General Account.” This influx of liquidity could buoy markets, including cryptocurrencies, by providing more capital for investment.
Conversely, the strengthening of the yen (“Liquidity Negative Force”), driven by the unwinding of the carry trade, would necessitate a global sell-off of financial assets as higher yen costs make debt servicing more expensive. This force could lead to a withdrawal of liquidity from markets, exerting downward pressure on asset prices, including cryptocurrencies.
Hayes proposes that the interplay of these forces will dictate the behavior of Bitcoin and other cryptocurrencies. He categorizes potential outcomes into two scenarios:
Convex-Bitcoin Scenario: In this scenario, Bitcoin could rise in value regardless of whether the dollar-yen pair strengthens or weakens, indicating that the market expects a bailout if the yen strengthens and that the liquidity provided by the US Treasury is sufficient to counteract the negative impacts.
Correlated-Bitcoin Scenario: Here, Bitcoin’s price movements would align closely with traditional financial markets. A strengthening yen would lead to a fall in Bitcoin prices, and a weakening yen would result in a rise, mirroring the liquidity shifts in traditional finance.
“If the setup is convex-Bitcoin, I will aggressively add positions as we have reached the local bottom. If the setup is correlated-Bitcoin, then I will sit on the sidelines and wait for the eventual market capitulation. The mega assumption is that the BOJ will not reverse course, cut deposit rates back to 0%, and resume unlimited JGB purchases. If the BOJ sticks by the plan it laid out at its last meeting, the carry trade unwind will continue,” Hayes concludes.
At press time, BTC traded at $57,200.
