A Brief Analysis of the Impact of Japan's Interest Rate Hike and U.S. Rate Cuts on Cryptocurrency Trends
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A Brief Analysis of the Impact of Japan's Interest Rate Hike and U.S. Rate Cuts on Cryptocurrency Trends
Was the flash crash on August 5 an isolated incident? Could it happen again in the future?
Navigating Web3 tides with focused insightsEditor: Wu Shuo Blockchain
In this issue, we revisit recent macro trends with Jiang Jinze, Chairman of MuseLabs—a global asset allocation research institute—and former Chief Researcher at Binance Research China. Following Japan's rate hike, global risk assets plunged sharply on August 5. However, Jiang does not view this as a typical crisis. He believes current data does not support the idea of a U.S. recession, and thus, there is potential for risk assets—including cryptocurrencies—to rise in Q4 following an expected U.S. rate cut in September. Ethereum’s price movement may resemble Bitcoin’s pattern around the launch of its ETF.
Was the August 5 crash an isolated event? Could it happen again?
When the event first occurred, markets were flooded with sensational headlines—claims of trillions or even tens of trillions in liquidations. In reality, the affected capital should be analyzed in two categories. The trigger was clearly the Bank of Japan’s unexpected reduction in bond purchases and interest rate hike—an unprecedented move in decades. When such a rare policy shift happens suddenly, market reactions are bound to be intense, especially since most market participants have never experienced anything like it in their careers.
Under the backdrop of ultra-low interest rates and prolonged liquidity provision by the Bank of Japan, significant risks had accumulated globally. Japanese capital has long flowed out to purchase higher-yielding assets like U.S. dollar-denominated securities. When this dynamic abruptly reversed, market panic was understandable. Against rising expectations of a U.S. economic slowdown, this dual shock amplified volatility across markets—not just crypto, but also foreign exchange. For instance, the yen surged 12% in a single day, a level of FX volatility unseen since the 1987 financial crisis.
It's important to distinguish between short-term leveraged positions and medium-to-long-term carry trades. One category consists of trend-following leveraged bets; the other involves longer-term arbitrage strategies. Their risk profiles differ. Currently, medium- and long-term carry positions are unlikely to unwind en masse, while short-term speculative positions have largely been digested post-event. Data on speculative net positions in the yen show that net short positions have rapidly declined over the past two weeks, indicating that short-term yen panic has mostly subsided.
Could other long-term carry trades still pose risks? High-frequency data shows that as of August 5, speculative yen positioning turned net positive, significantly reducing the likelihood of further sharp yen depreciation. A 10% move in FX markets within a short period is typically sufficient to clear all leveraged positions, suggesting that the market may have already formed a "golden buying opportunity" during the selloff.
Equity markets are more complex due to their intrinsic cash flows. While exchange rate shifts affect equities, their volatility is generally much lower than in FX markets. Thus, FX becomes a key barometer of overall sentiment. Once the downward trend in USD/JPY stabilizes, broader market panic is unlikely to intensify.
Japanese carry trades actually have a dual nature. On one hand, domestic investors borrow cheap yen to invest in high-yield overseas assets. On the other, some investors pledge foreign assets to borrow yen and invest in Japanese domestic instruments. Although yen appreciation could hurt carry trade profits, bond market behavior suggests no widespread capital flight or systemic distress.
Therefore, the August 5 flash crash, while significant, appears more like a short-term market fluctuation driven by multiple converging factors. Whether similar volatility recurs will depend on global economic conditions and central bank policies. Yet, existing data indicates the market has largely absorbed the impact of this episode.
The August 5 event doesn’t seem to be a liquidity crisis—likely not worth worrying about
Judging from Treasury and other market performances, the so-called unwinding of yen carry trades either hasn't truly materialized or isn't severe. This was largely a sentiment-driven reaction. Hence, the episode doesn’t resemble a classic crisis. In a real liquidity crunch, the U.S. dollar would strengthen—but in fact, the DXY index fell in those days. During genuine crises, all assets including stocks, bonds, and gold decline together, which didn’t happen here. Therefore, it can be concluded that this wasn’t a systemic panic event—at least not among major institutional players.
This situation allows for two interpretations: either the market might keep falling until large players panic and exit (indicating no bottom yet), or the stability of big money signals that the bottom may already be in. In such ambiguity, each investor should act according to their own position and strategy.
Further indicators suggest minimal cause for alarm. Global fund flow data reveals that despite corrections, both global stock and bond markets saw inflows over the past four weeks. Even if money market funds experienced outflows, this may simply reflect carry trade unwinds rather than broad-based fear.
From a risk perspective, both safe-haven and high-risk assets attracted inflows, showing no sign of mass capital flight during the dip. Deutsche Bank’s analysis of various investment strategies also shows only minor drawdowns in systematic and trend-following strategies, confirming low levels of market panic.
Overall, growing evidence points to a non-panicked market. In the past two weeks, many institutions have shown intent to buy the dip. While short-term nervousness hasn’t fully vanished, it has likely been overstated. As for future rate hikes by the Bank of Japan, recent statements have softened, and such aggressive policy shifts appear highly improbable in the long run.
Analyzing Arthur Hayes’ latest article
I noticed you translated and distributed Arthur Hayes’ (aka “Little Black”) article yesterday, which referenced a balance sheet of the Japanese government. However, the data used in the piece is not up-to-date—it’s from two years ago. Still, it remains roughly indicative. Some parts may be hard for general readers to grasp, but certain arguments hold merit. For example, he correctly notes that Japan has stimulated growth by suppressing the liability side of its balance sheet through ultra-low-cost financing. A deliberate rate hike would essentially burst its own bubble. Given that Japan’s government debt exceeds five times its GDP, raising funding costs seems unimaginable.
Hayes argues that the Japanese government itself is one of the largest carry trade participants. If rate hikes were to unwind all carry trades, the government would be the first casualty. Thus, despite hawkish comments from central bankers, sustained rate hikes remain unlikely. I believe these hawkish tones were largely performative—and indeed, the BOJ quickly shifted its tone afterward. Under these circumstances, fears of a large-scale reversal of carry capital are largely unfounded, as Tokyo won’t willingly raise its borrowing costs.
Japan engages in carry trades not just domestically but extensively abroad, holding foreign securities equivalent to about 50% of GDP—roughly $2 trillion. This means the government and affiliated entities are deeply involved in overseas arbitrage, with private-sector activity likely even larger. Consequently, this carry model is unlikely to undergo fundamental change in the near term.
Some parts of Hayes’ article are exaggerated—for example, claiming Japan’s carry trade exposure reaches 505% of GDP. In reality, adding both funding liabilities and asset holdings inflates the figure. A more accurate estimate puts Japan’s foreign security holdings at around $2 trillion, not the 20 trillion yen often cited in media reports.
Overall, while Hayes’ article contains exaggerations, it offers useful insights into Japan’s economic model and carry trade structure. However, his “great collapse” thesis shouldn’t be taken too seriously or feared excessively.
Is the U.S. economy in recession?
Whether the U.S. economy is in recession depends on perspective. Media often focus on changes in new data while ignoring存量 (stock) metrics, leading easily to pessimistic conclusions. Bad news spreads faster, so relying solely on headlines might make one believe the U.S. is indeed sliding into recession.
However, looking at the broader picture, the situation may not be so dire. First, U.S. manufacturing PMI has consistently underperformed—but this reflects long-standing deindustrialization. Declining labor skills and rising wages highlight structural challenges in manufacturing. Unless PMI shows extreme deterioration, using it alone to gauge overall economic health can be misleading.
More importantly, overall economic performance remains solid. U.S. Q2 GDP grew at 2.8%, well above expectations, signaling strong economic momentum. Forecasts for the next two quarters stand at 2.6% and 2.5%, respectively—no signs of imminent contraction. Price levels are gradually declining, inflation expectations are anchored, and interest rates are poised to fall. While the labor market isn’t perfect, unemployment hasn’t spiked dramatically.
High-frequency data collectively indicate ongoing economic expansion. Most indicators align with market expectations. Financial conditions indices show no tightening in credit markets—in fact, conditions have eased slightly since June. Therefore, available data do not support a recession call.
Current recession discussions center on manufacturing PMI and unemployment. But in this cycle, many traditional macro indicators have failed. For instance, yield curve inversion usually predicts recessions reliably—but despite two years of inverted curves in the U.S., no recession has followed. Similarly, shrinking base money supply typically leads to falling asset prices, yet U.S. asset values have risen across the board over the past two years.
In sum, while some indicators suggest slowing growth, the overall picture does not confirm a U.S. recession.
If the U.S. isn’t in recession, why is there a 'recession trade'?
Relying solely on unemployment to determine recession status is insufficient. Most data don’t support a recession narrative. The so-called “recession trade” exists for other reasons.
A key reason is excessive concentration in mega-tech stocks. Over recent quarters, tech giants have consistently beaten earnings forecasts, leading to investor “aesthetic fatigue.” Stock markets trade on future expectations—even when results beat forecasts, investors begin scrutinizing the margin of outperformance rather than absolute outcomes. When the degree of surprise shrinks, capital starts exiting—even if fundamentals remain healthy.
Ahead of Q2 earnings season, expectations for big tech were already sky-high. Actual results, though positive, showed narrowing beats. This prompted pre-earnings de-risking—exemplified by Buffett beginning to divest in June and rotate into other sectors. During this process, capital rotated out of tech not into safe havens or fixed income, but into previously lagging companies. This reallocation reflects style rotation, not reduced risk appetite.
This capital shift has little to do with actual recession expectations. The equity pullback stems more from overcrowded tech positions than direct economic weakness. Linking stock declines to recession trading is therefore somewhat misplaced.
For U.S. equities, consistent capital inflows are normal—deeply tied to the structure of the American economy. As long as U.S. consumers spend, corporations earn, and dollars continue flowing into U.S. stocks and Treasuries. While this model may face long-term challenges, in the short term, U.S. stocks and bonds remain relatively safe bets.
Regarding big tech, market sentiment is now reassessing AI’s real-world impact. Many institutions question whether AI can meaningfully boost productivity. Despite promising technology, open-source models and fierce competition may limit actual financial gains for firms. This skepticism adds downward pressure on tech valuations.
In conclusion, while the U.S. economy is not in recession, the “recession trade” reflects rebalancing from overexposed tech positions and shifting forward expectations—not a direct reflection of deteriorating fundamentals.
Will risk assets surge after U.S. rate cuts?
I believe there is potential for a significant rally in risk assets following Fed rate cuts—but context matters. If U.S. economic data maintain current trends without accelerating deterioration, rate cuts would undoubtedly be supportive. However, the September rate cut has already been heavily priced in. Two weeks ago, odds exceeded 50%; recently, they’ve climbed above 90%. So even if a cut occurs, the market reaction may be muted.
Even with a 25 or 50 basis point cut, the U.S. risk-free rate will remain around 4.8%. For non-cash-flow-generating assets like cryptocurrencies, such a change won’t drastically enhance attractiveness. Thus, rate cuts mainly influence sentiment, not liquidity supply.
In this environment, we must closely monitor shifts in expectations and sentiment. If the September cut exceeds expectations—or if Fed guidance signals a clearly dovish path forward—markets could see a stronger rebound. Conversely, if the cut is exactly 25 bps and officials remain cautious, disappointment may follow, limiting gains in risk assets.
Additionally, if economic indicators suddenly deteriorate, signaling a real U.S. recession, even rate cuts may fail to lift risk assets. In true recessions, monetary easing alone cannot reverse economic decline, prompting investors to flee toward safer assets like defensive stocks or bonds.
Overall, the impact of Fed rate cuts hinges on economic data and market psychology. If cuts are seen as confidence-building and exceed expectations in magnitude or forward guidance, risk assets could surge. But if cuts appear symbolic, accompanied by cautious rhetoric, the response may be tepid. Finally, close attention must be paid to Fed officials’ communications to gauge their views on market sentiment and economic outlook.
Why is Ethereum so weak, and what’s next?
Currently, Ethereum’s weakness closely mirrors Bitcoin’s. Before the official launch of Ethereum ETFs, prices rose, but the rollout was abrupt, resulting in a shorter hype cycle compared to Bitcoin’s prolonged buildup last year. Without favorable timing, Ethereum couldn’t fully capitalize on macro tailwinds. The ETF launch lacked “perfect timing,” limiting its upside.
Moreover, Ethereum faced selling pressure from Bitcoin during this rally. Multiple unlock events, along with sales by governments and bankrupt entities in the Bitcoin space, dampened market sentiment, capping ETH’s gains. After ETF listings, both Ethereum and Bitcoin saw a classic “sell the news” reaction—prices dropped post-announcement. Graystone unlocking added further downward pressure on Ethereum.
Looking ahead, Ethereum may follow Bitcoin’s prior trajectory. After Bitcoin ETFs launched, prices initially fell but later rebounded as selling pressure eased and net inflows resumed. Similarly, Ethereum’s future path may hinge on how quickly Graystone-related selling is absorbed and how strongly other Ethereum ETFs attract subscriptions. If Ethereum sees sustained net inflows, sentiment could gradually recover, supporting price recovery.
Also, market expectations around ETFs may involve some misconceptions. While ETF launches generated attention, growth may not meet inflated expectations. Actual data show rapid adoption: IBIT already counts 615 institutional holders, indicating strong ongoing interest. Therefore, despite recent weakness, Ethereum’s long-term prospects remain positive as markets mature and capital continues flowing in.
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