(Kitco News) - Global assets are facing a big problem, and this trade "unwinding" is the one to watch, according to James Lavish, co-managing partner of Bitcoin Opportunity Fund and author of the Informationist Newsletter.
The widespread market selloff is in part being driven by the yen's recent turnaround after the Bank of Japan (BOJ) raised interest rates for the first time in decades, with the latest hike just last week. The BOJ decided to hike short-term rates to 0.25% from 0-0.1% at the July 30-31 meeting.
"You've had extraordinarily low borrowing costs in Japan for over a decade. As we were coming out of the pandemic, all central banks were raising their rates, while Japan was actively holding their rates down to induce inflation," Lavish told Michelle Makori, Lead Anchor and Editor-in-Chief at Kitco News. "This matters because if you are an investor. What you can do is sell short Japanese bonds. For that, you're going to receive yen, and you can take those yen and sell them and buy dollars. Then, you can take those dollars and buy the higher-yielding U.S. Treasuries."
However, what happens is those investors are then buying assets around the world, not just bonds for higher yield.
"They're able to borrow from the Bank of Japan for basically free and then turn around and buy risk assets around the world," Lavish pointed out. "We've been watching that over the last number of years. And now that carry trade is getting unwound. You're seeing risk assets get unwound along with it because they've got to pay off that loan before it gets upside down on them."
For insights on this carry trade, watch the video above.
Monday witnessed a global market meltdown. Japanese stocks tumbled down, with the Nikkei share average seeing a 12.4% drop - marking the second-largest decline on record and the biggest since the infamous Black Monday crash of October 1987.
Europe's Stoxx 600 index closed 2.17% lower Monday, pulling back from more than 3% declines earlier in the session.
U.S. stocks also fell sharply, with the Dow and S&P 500 posting their biggest daily losses since September 2022. The Dow closed down more than 1,000 points or 2.6%, the S&P 500 fell 3% and the Nasdaq was down 3.4%.
At the same time, Wall Street's 'fear gauge' – the Cboe Volatility Index (VIX) – has surged to its highest level since the pandemic market plunge in 2020 on Monday. The VIX briefly rose above 65, up from about 23 on Friday and around 17 a week ago. At the time of writing, the index has cooled to 37.55.
America's markets are also reacting to rising recession fears following Friday's disappointing July jobs report, which showed the U.S. economy adding only 114,000 positions. The number fell short of the 175,000 expected jobs, marking one of the weakest job growth rates since the pandemic. Meanwhile, the unemployment rate rose to 4.3%, the highest in nearly three years.
According to Lavish, the current economic turmoil will inevitably lead to more money printing and liquidity injections by the Federal Reserve, even as the U.S. national debt surpasses $35 trillion for the first time.
"We're going to have to print money unless we want to go into a period of massive turmoil and a total reset of our economy," he said. "We just crossed $35 trillion of national debt. No matter what, all roads lead to more printing and more liquidity. You're going to have the Treasury and the Fed team up and start buying bonds again; there's just absolutely no way around it. If we do have a sharp downturn, there's no way out."
After keeping rates steady in July, can the Federal Reserve announce an inter-meeting cut prior to the market's September rate cut projections? Watch the video above to get insights.
Lavish also shares his price outlook for gold and Bitcoin in light of this market selloff and the Fed's next steps. For his forecasts, watch the video above.
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