The Widowmaker trade is a term used in finance to describe a trade or investment strategy that has historically led to significant losses for those who attempt it. The Widowmaker trade became famous in the 1990s and 2000s. One of the most famous “widowmaker trades” was a bet on the price of Japanese Government Bonds (JGB) going down. Given the Japanese government’s ever-growing debt levels, many traders assumed that the Bank of Japan would not be able to maintain 0%, or even negative interest rates, permanently. Yet, anyone who bet against JGBs lost for over 3 decades running, hence the name ‘Widowmaker’.
How Japan’s Rate Hike Triggered a Chain Reaction in Stocks and Crypto
Last week, the tables finally turned. When the Bank of Japan announced a surprise rate increase to 0.25%, markets panicked. On Monday, the Japanese stock index Nikkei, crashed over 10%, dragging all other markets including Crypto with it. Within hours, Bitcoin dropped from a price of $60k all the way down to $49k at its lowest point. Billions in leveraged positions of traders were liquidated both in crypto as well as in stocks. Ethereum recorded its worst single-day drop since May 2021. In Crypto alone, over 200,000 traders were liquidated across exchanges in a 24 hour period.
How did a relatively small rate increase in Japan cause such havoc? First of all, it followed on the back of disappointing US economic data. Traders that had hoped the Federal Reserve would announce rate cuts were disappointed. Also, the hype for AI and tech stocks has visibly calmed. But the true importance of the Japanese decision on global markets was that it dismantled one of the major international financial arbitrage opportunities known as a ‘carry trade’.
Banks and funds borrowed cheaply in Japanese YEN, swapped YEN to USD or other currencies, and bought higher-performing assets such as tech stocks. As stock prices went down and the cost of borrowing up, market participants quickly had to unwind large positions to reduce their exposure to increased borrowing costs in their YEN positions. This is the Traditional Finance version of what crypto experienced in the spring and summer of 2022 when Luna/Terra, Three Arrow Capital, and lending platforms such as Celsius all blew up after piling into Grayscale’s GBTC fund.
Resilience Amidst Market Turbulence as Crypto Awaits Next Moves
The long-awaited breakout to the downside finally happened. When Bitcoin’s parabolic rise earlier in the year had run out of steam, its price setup inevitably became vulnerable to surprise events which end up pushing the market down. The good news is that the Japanese carry trade unwound quickly. According to JPMorgan, around three-quarters have been removed. Both the Federal Reserve and the Bank of Japan have reassured markets. The rebound has been surprisingly strong. As of the end of the week, Bitcoin recouped the entirety of its losses and traded once again above the $60k price mark.
The ‘good’ story is the underlying strength that Bitcoin demonstrated. Meanwhile, the rest of the crypto market remains in wait mode. Ethereum is still substantially below the $3k mark. Many risks remain on the horizon. Further US economic weakness could push markets down further. On the other hand, the expectation that the Federal Reserve will finally begin reversing rate hikes is the hope for many market participants. Short-term pain might still await but markets are hoping for a more promising end to the year.
Conclusion
the market’s reaction to Japan’s unexpected rate hike highlights the interconnectedness of global finance and the sensitivity of both traditional and crypto markets to economic shifts. While the initial shock was severe, with widespread liquidations and significant price drops, the swift recovery of Bitcoin suggests underlying resilience. However, the broader market, particularly Ethereum and other cryptocurrencies, remains cautious as participants weigh ongoing risks against potential future opportunities. As the year progresses, much will depend on the economic developments in the U.S. and the actions of central banks. While short-term volatility is likely, there is cautious optimism that a more stable and favorable environment could emerge in the months ahead.
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