new York
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Crypto had a rough November. The pain continues into December – and that could signal trouble ahead for the stock market.
Bitcoin has fallen more than 6% in the past 24 hours, from just over $91,000 to around $85,600 as of Monday afternoon. The cryptocurrency sold off sharply on Sunday evening – falling more than $4,000 in just a few hours – as December trading got underway in Asia.
Bitcoin has seen intense fluctuations in recent weeks as risk aversion has spread across markets. In addition to a risk-averse attitude, the latest panic in the crypto world stems from concerns over the course of a popular trading strategy.
So what’s going on?
The Bank of Japan has indicated it may raise interest rates at its policy meeting later this month. This undermines a business strategy that relies on borrowing relatively cheap Japanese yen.
For years, a lucrative trade for global investors has been borrowing yen to buy high-yielding assets like U.S. stocks or, in this case, cryptocurrencies. Interest rates in Japan were low to zero, making borrowing yen relatively cheap and creating a nice opportunity for traders. This is called the yen carry trade.
However, the Bank of Japan has indicated it may raise interest rates, in part to combat stubborn inflation, continuing its recent move away from years of ultra-low rates. Yields on Japanese benchmark bonds just hit their highest level since 2008, signaling expectations for higher rates. Rising rates in Japan can cause the value of the yen to rise. This makes borrowing the yen less affordable, which erodes the profitability of the carry trade.
This could push traders to sell their bitcoins and stocks now to repay their loans and avoid any risk of further losses. In addition to a massive sell-off, this could lead to a decrease in liquidity flows into crypto and stocks.
“This raises questions about the unwinding of the yen carry trade…which would drain liquidity from the system,” Matt Maley, chief market strategist at Miller Tabak + Co, said in a note. “That wouldn’t be good for the stock market.”
Bitcoin fell below $84,000 on Monday morning before paring some losses in the afternoon. US stocks closed lower: the Dow Jones fell 427 points, or 0.9%. The S&P 500 fell 0.53% and the tech-heavy Nasdaq Composite fell 0.38%.
For cryptocurrencies, the sell-off was widespread: Ether, the world’s second-largest cryptocurrency by market value, fell almost 9% in the past 24 hours.
Bitcoin’s fall follows a sharp sell-off in crypto markets just a few weeks ago. In late November, Bitcoin fell to just above $80,000, down about 35% from a record high of over $126,000 in early October.
The decline in bitcoin led to a decline in stocks and, in particular, technology stocks that were carrying the market. The S&P 500 fell nearly 5% at one point in November before recovering and gaining slightly for the month. The tech-heavy Nasdaq recorded its first losing month since March.
The markets “are not out of the woods yet,” Maley said.
“Bitcoin’s further decline could create real problems for the stock market,” he said in a note. “If the issues causing this decline do not abate, the year-end recovery scenario will face real headwinds.”
A sign of their aversion to risk, investors are turning again to gold and silver, which are considered safe havens in a context of uncertainty. The price of silver hit a record high on Monday as investors snapped up the metal, which can be seen as a cheaper alternative to gold. Silver prices have doubled this year and have also been boosted by increased industrial demand.
Bitcoin proponents say volatility is part of the journey. Meanwhile, critics say Bitcoin does not live up to its proposed use as a store of value, given its susceptibility to intense fluctuations. Bitcoin is now down about 9% this year, while the S&P 500 is up about 16% and gold is up almost 62%.
All things considered, the S&P 500 is less than 2% below its record high set in late October. December is a historically strong month for markets, and Wall Street is betting that the Federal Reserve will cut interest rates this month, which could boost stocks. However, more volatility could be expected as bitcoin languishes more than 30% below its all-time high and nerves persist over the yen carry trade.
“With all of this in mind, we are still at a key moment for the stock market,” Maley said. “Developments in Japan are creating some uncertainty about a year-end rally…so the ‘all clear’ flags are not yet flying high.”
