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Good morning everyone,

It's been a rollercoaster week.

On Friday last week, Bitcoin went on a mad dive that accelerated over the weekend.

On Monday, it fell below USD50000, after almost reaching USD70000 on 29 July. In short, Bitcoin plunged by more than 25% or almost USD20000 in one week. Yes, historically, Bitcoin has seen bigger pullbacks in bull markets, but believe me, a 25% plunge in just a few days hurts even the most seasoned Bitcoin investor.

This week, I'm going to dive into the reasons behind the market downturn and what we can expect from here.

DISCLAIMER: This newsletter is not financial advice. It does not take into account your financial situation, is general in nature, and is for educational purposes only.

Also, this newsletter contains affiliate links. This means that I may receive a commission from them. But for Crypto Down Under, I only choose products I use myself and can recommend wholeheartedly. Don’t forget to do your own research.

1. The unwinding of the carry trade

One thing that has spooked investors around the world is the unwinding of the so-called carry trade.

In plain English, the carry trade refers to:

• People borrowing Japanese Yen at 0% interest rates

• Converting the Japanese Yen into US Dollars

• Investing the US dollars in US stocks and bonds in the expectation of a higher return

The carry trade was made possible by the divergence in interest rates between Japan and the US. The Bank of Japan has kept interest rates at or near zero for years in an attempt to encourage more spending and stimulate economic growth. The Fed, on the other hand, has raised interest rates to a target rate of 5.25-5.5% over the past two years in an attempt to fight inflation.

However, on 31 July the Bank of Japan raised interest rates by 0.25% in a bid to strengthen the Yen. The move threw a wrench into the popular trading strategy and sent investors into a panic.

However, on Wednesday the Bank of Japan said it wouldn't raise interest rates any further as long as markets were unstable.

Long story short: Basically, the unwinding of the carry trade was the bursting of a bubble in the market. It led to panic selling. Panic has subsided and the Bank of Japan isn't going to add fuel to the fire by continuing to raise rates just yet.

2. Fears of recession

Also last Friday, the US unemployment rate rose to a near three-year high of 4.3% in July. The increase from 4.1% in June marked the fourth consecutive monthly rise.

The slowdown in hiring has heightened fears that the labor market is deteriorating and that the economy may be vulnerable to a recession.

Some heavyweights, such as JP Morgan CEO Jamie Dimon, have since come out and said they believe a recession is the most likely scenario.

Long story short: There are fears that the US could be heading for a recession, the technical term for two consecutive quarters of negative gross domestic product (GDP) growth. Going forward, these fears could be exacerbated by poor labor market figures.

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3. Is a crypto trading giant in trouble?

While the unwinding of the carry trade and the rise in US unemployment are macroeconomic factors that drove all markets around the world lower, there was also a crypto-specific catalyst behind the crypto market downturn.

Chicago-based trading firm Jump Trading moved large amounts of ether to centralized exchanges as the crypto markets tumbled, a move often associated with an intention to sell.

It doesn't make sense for a large trading firm to be selling crypto when prices are in freefall. So market participants have speculated that Jump Trading had a margin call on a loan, or had to sell assets due to a legal battle with the regulator.

Long story short: Whatever the reason, the dust hasn't settled yet. There's also the theory that while Jump Trading may have shut down its blockchain development arm, the crypto trading business may continue as before. We'll have to wait and see.

4. Fears of war in the Middle East

In recent days, Israel has claimed responsibility for the assassination of a senior Hezbollah commander in Lebanon and a senior Hamas leader in Iran.

Iran and Hezbollah have since vowed to punish Israel.

This has raised fears of all-out war in the Middle East.

Long story short: Since the Hamas attack on Israel on 7 October, Israel and the terrorist organization Hamas have been at war. Hamas and the terrorist group Hezbollah are allies, and Hezbollah is backed by Iran. The worst-case scenario for this conflict is an open war between the arch-enemies Israel and Iran.

5. What next?

Let's leave aside geopolitics and the fate of trading company Jump Trading because they are unpredictable.

The other two macroeconomic factors, the unwinding of the carry trade and recession fears, have one thing in common:

They are bad news that could prompt the Fed to act sooner than expected.

Some seasoned market observers called for an emergency Fed rate cut to calm the markets this week. While it doesn't look like the Fed is going to do an emergency rate cut, market observers are now expecting a higher rate cut in September.

When I wrote my newsletter last week, the odds of a 0.25% rate cut were 86.5% and the odds of a 0.50% rate cut were 13.5%.

After this week's market turmoil, the odds have shifted dramatically to 31% for a 0.25% rate cut and 69% for a 0.50% rate cut, according to the CME FedWatch tool.

In other words, most market observers now expect a 0.50% rate cut in September rather than a 0.25% cut. 

Long story short: Markets are forward-looking. They anticipate that bad news will prompt governments to act, cut interest rates, and pump money into the economy. And that's fuel for asset price appreciation.

Have a great weekend, everyone!

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