The Breakdown - What Drove the Market Crash

Episode Date: August 6, 2024

The market hemorrhaged on Monday, and it was preceded by a big move down in Bitcoin and crypto. NLW explains the most likely causes, including the Japanese Yen Carry trade unwind, the jobs report, and more. Enjoying this content? SUBSCRIBE to the Podcast: https://pod.link/1438693620 Watch on YouTube: https://www.youtube.com/nathanielwhittemorecrypto Subscribe to the newsletter: https://breakdown.beehiiv.com/ Join the discussion: https://discord.gg/VrKRrfKCz8 Follow on Twitter: NLW: https://twitter.com/nlw Breakdown: https://twitter.com/BreakdownNLW

Welcome back to The Breakdown with me, NLW. It's a daily podcast on macro, Bitcoin, and the big picture power shifts remaking our world. What's going on, guys? It is Monday, August 5th, and today we are talking about the big Bitcoin and broader market crash. Before we get into that, however, if you are enjoying the breakdown, please go subscribe to it, give it a rating, give it a review, or if you want to dive deeper into the conversation. Come join us on the Breakers Discord. You can find a link in the show notes or go to bit.ly slash breakdown pod. Hello friends. It was a brutal one today. I guess for us over here in Crypto Land, it's been brutal for a little bit longer than everyone else. But today we are obviously talking about the market crash. What if anything Bitcoin or Crypto has to do with it? What happened in those areas? And just generally, we're going to try to get a sense of what the hell is going on.

Maybe for the sake of fidelity to this show, let's start with the crypto side of the equation, where Bitcoin sold off hard on Sunday night, which was frankly capping off a rough week already for crypto markets. Even before the Sunday night flush, it had already been the worst week since the FTX collapsed back in November 2022. As I record, Bitcoin is trading around $53,000 after beginning last week at $69,500. Alter an absolute bloodbath with most prominent tokens down 15% or more overnight. Ethereum is faring even worse, suffering a 23% drawdown last night and losing a third of its value over the weekend. It is now round-tripped an entire year worth of price action. I saw a meme that said Ethereum 2.0? Ethereum to zero. Total open interest for crypto futures has declined by almost 40% over the past week,

with over 800 million in liquidations on Sunday. Now, the only news that comes from the crypto world that comes anywhere near close to explaining that price action was jump trading exiting their Ethereum position. The marketmaker is reportedly under CFTC investigation after being mentioned in the Luna and Binance lawsuits last year. They had been unstaking Heath over the past two weeks, and on Sunday they send over 300 million worth to exchanges. At this stage, we don't know if the firm is winding up operations or merely going completely risk off. In terms of short-term market impact, it probably doesn't matter which one is true. The comparisons are easy to draw. With Crypto-McCena tweeting, this was probably the largest unwind I've seen since the COVID crash in 2020. By this morning,

more than $400 billion in total market cap had been shed since Friday. Then again, crypto markets are just a tiny slice of what was ultimately a global meltdown in risk assets. Friday saw the S&P 500 fall by 1.8% with the NASDAQ losing 2.4%. The current three-week drawdown in U.S. stocks had wiped out gains dating back to June. It was the largest decline since 2022 and showed no signs of reaching a bottom. In fact, at the open this morning, stocks would absolutely crater again before regaining a little bit over the course of the day. Monday morning openings were also scary across Asia. Japan's Niki index fell 4.6% in the first 20 minutes of trading, and the 12% collapsed across the trading day was the worst crash since Black Monday in 1987. Taiwan's market index fell by 7%, which was the

biggest single-day drop since 1976. South Korea's KOSPI index fell by 5%, triggering circuit breakers that suspended algorithmic trading for five minutes. The volatility index is highly elevated, and risk managers are frantically tapping shoulders as we head into what could be a rocky week. Many, if not most, commentators in crypto, noted that this really felt like a macro-related correction. Yesterday, Ryan Schott Adams tweeted, haven't seen a pain day like this in crypto, a while. I'd say it's like 2022, but actually it feels more like March 2020. Macro has the wheel. Hello, friends. Before we get back to the rest of the show, I want to implore you to join me at Permissionless. Permissionless is the conference for Cryptonatives by CryptoNatives,

and the reason it's so important this year is that despite regulators' best attempts to push industry founders, devs, and executives out of the U.S., the United States remains the beating heart of crypto. Today, the tide is turning. Policymakers have pivoted from fighting crypto to embracing it. Literally now, we are in a major political parties platform, which will lead ultimately to the creation of new financial products, new applications, and ultimately new adoption. Permissionless is the conference for those using and building on-chain products. It's home to the power users, the devs, and the builders. And perhaps more importantly, I will be there. The location is Salt Lake City, the dates are October 9th to the 11th, and tickets are just $499.

If you want to get 10% off, use code breakdown 10. Go to the Blockworks website, blockworks.com. There will be links to register for the conference, and again, you can use code breakdown 10 to get 10% off. So what are the catalyst that people are pointing to? Well, the first major catalyst is a huge miss on Friday's job report. In July, non-farm payrolls grew by just 114,000, far below estimates of 185,000 and the 179,000 gain in June.

We've also seen five out of the last six payroll numbers revised down, so this data might not even reflect how badly the labor market is turned. Lynn Alden commented, the technical term for the payroll report that just came out is dumpster fire. The unemployment rate ticked higher for the fourth month in a row, reaching 4.3%. The SOM rule has now been triggered with a half-percentage point increase in the three-month average unemployment compared to the low over the past year. This indicator has a near-perfect record for signaling that a U.S. recession has already begun,

and that the unemployment rate is about to go upstate. significantly. Jerome Powell referenced this indicator directly at last week's Fed press conference being slightly dismissive and calling it a, quote, statistical regularity rather than an ironclad rule. On Friday, Claudia Sam herself, the creator of the rule, talked down the possibility, saying, we're not in a recession when you look broadly across all of the indicators. We're in a place where things have slowed. What is very worrisome is that the momentum is not good. We are pointed towards what would be called recessionary dynamics, and that should be a real wake-up call. The reason this might be a false indication is the unusual dynamics of the current labor

market. As SOM said, the SOM rule is likely overstating the labor market's weakening due to the unusual shifts in labor supply caused by the pandemic in immigration. Others took the indicator on face value, with David Rosenberg tweeting, for example, the SOM rule triggered the recession call today. The Fed is as behind the economic curve now as it was behind the inflation curve back in 2021-2020. Most of this tightening phase in cyclical bare market in bonds is set to unwind in dramatic fashion. So just four days out from the FOMC meeting, the Fed now has an exceptionally weak job print and a stock market meltdown to contend with. The policy stance was that rate should be held steady to wait for more data and that a 50 basis point rate cut in September wasn't on the table.

Powell said that the Fed was, quote, well positioned to respond to any major downturn in the labor market, and the general take from pundits at the time was that the waitancy approach wasn't too much of a risk. As we said before, following the meeting, Jeffrey Gunlock of double-line capital said that while he would have preferred to see the first rate cut, quote, what difference does six weeks make? The answer apparently is quite a bit. In that short span of time, markets have gone from pricing the odds of a 50 basis point cut in September at 10% to almost a 100% certainty. Early this morning, there were rumors of an emergency meeting to discuss an intermediing rate cut, but that didn't really seem to bear out. The broad sense is that that would be too much of a

sign of panic, with Felix Javan, the host of On the Margin tweeting, an intermediate cut if it were to happen, is an example of a bearish panic cut and very different from the normalization cuts I've talked about being the most likely. Banks are also rapidly revising their interest rate predictions. Both JPMorgan and City are now predicting five rate cuts to end the year front-loaded in September and November. Last week, consensus was split between three and four cuts. Shouting from the usual suspects is intensifying with billionaire hedge funder Bill Ackman tweeting, the Federal Reserve was too slow to raise rates. Now, it is too slow to lower them. We're now looking at the potential that the Fed is way behind the curve and will

need to play catch-up with some aggressive moves. Even Nobel laureate, Paul Krugman has stopped carrying water for the Powell Fed. On Friday, he called last week's decision a big oopsie. In the New York Times opinion pages, Krugman pointed out, this is the second time the Fed has found itself behind the curve during this policy cycle. However, he noted that longer-term rates, which are used to price loans in the real economy, have already begun to move in anticipation of rate cuts, perhaps dampening the impact of a policy mistake. In conclusion, he wrote, even though the Fed has gotten behind the curve, it may still be able to head off a recession by signaling to markets that it knows it as ground to make up. We should definitely be looking at a rate cut of a half a percentage

point, rather than the usual quarter point move at its next scheduled meeting. Connor Sen, an opinion columnist at Bloomberg, thinks the Fed should just rip the bandaid off. He tweeted, in my lifetime anyway, every time the Fed has panicked, it's been the correct decision. It's resisting panic in the name of stubbornness that sometimes has gotten them into trouble. Now, the other big catalyst on everyone's mind is the unwind of the yen carry trade. In the simplest possible terms, the trade involves borrowing yen from Japan and using it to fund other positions. This was enabled by Japanese rates remaining at zero while other yields rose in other currencies. One of the more popular positions was investing in Mexican peso-denominated bonds,

as short-term interest rates have been above 11% for more than a year. That's just one example of a very simple trade, but institutions who can borrow in yen use the same principles to lever up all sorts of positions from interest rate arbitrage to tech stock trades. As well as being cheap, this funding mechanism was also viewed as extremely stable. In a very real way, ultra-low Japanese interest rates are the bedrock of leverage in the financial system and have been for more than a decade. The past few months have seen relative weakness in the yen making this trade even more appealing. The yen was down by more than 12% since the beginning of the year,

making these yen-denominated loans much easier to repay. Over the past few weeks, however, the yen has been violently strengthening. This rapid currency move was amplified last week when the Bank of Japan delivered a surprise interest rate hike shortly before the Fed meeting. This brought interest rates to 0.25%, their first time firmly in positive territory since 2008. The yen has been ripping higher since that policy decision up around 4.5% over the last few days. All of that weakness then from the past year has unwound over the space of a couple of weeks. Institutions that are still in the carry trade are now faced with a double whammy of higher interest rates on loans, coupled with increased principal value if they choose to repay. At a minimum, this dynamic

reigns in leverage across global financial markets, and at worst, it can cause a violent unwind as firm scramble to sell what they can to get out of positions that have turned against them. John Wu of Asylum Ventures tweeted, It seems unintuitive that a small 25 basis point interest rate hike in Japan would spike all risk assets, including tonight's negative 20% ETH candle. But you need to understand the way the carry trade works. It's a leveraged unwinding. And that's really the point, that this is a massive global leverage unwind, not simply a sell-off. We've seen these before in crypto markets, but they always surprise us in just how violent they can be. While unwinds in crypto can be as large as a few billion dollars,

the Bank for International Settlements estimates that there were more than $2 trillion in cross-border yen-denominated claims at the end of the first quarter. Still, for as concerned as some are, others basically are arguing that this was unavoidable. Mark Dow, for example, tweeted, you can talk about the Fed and the BOJ and the carry trade all you want, but when you have one million consecutive trading days without a greater than 2% move in the major indices, the VIX is living at 12% and implied correlations are freakishly low, it means people are getting greedy and reaching for risk and you eventually get a big unwind. There is nothing new under the sun.

Still, if you need more convincing that this could be the big one, Warren Buffett has been selling a huge amount of stock over the last few weeks. Berkshire Hathaway has slashed their Apple holdings by 50% and trimmed their Bank of America position by 8.8%, probably in recognition of them deplatforming me. The second quarter was the most selling Berkshire has ever done. The firm is going into cash and now has a real. record high $277 billion invested in treasuries. Berkshire has been slowly building this defensive position over the past two years, but this is a step change for the strategy. The cash pile

grew by around 50% in quarter two, which, to give a sense of scale, Buffett now has a large enough cash reserve to buy companies like Netflix, Salesforce, or Toyota outright. At the annual shareholders meeting in May, he said he wasn't really looking for anything other than safety for the moment. He commented that Berkshire wasn't looking to spend the cash, quote, unless we think we're doing something that has very little risk and can make us a lot of money. Aside from those glaring warning signs, there's a ton of other news flashing across the headlines as well. High-yield credit spreads have begun to blow out, which is a sure-fire sign that credit stress is increasing. There's still a major question mark about how much hidden risk has been buried in private credit and private equity markets that will still need to surface.

Outside of financial markets, it also seems as though escalation in the Middle East is on the table. Iran has threatened to retaliate against Israel for the assassination of a high-ranking political leader last week, and on Sunday, Goldman Sachs economists updated their call to a 25% chance of a U.S. recession this year. now for as freaked out as traditional markets are, season crypto traders are a little bit more sanguine. Before the Asian session, Bitmex founder Arthur Hayes tweeted, Good morning, fam, I pray for your souls. Hold on to your butts. It's about to get nasty. I effing love volatility. Yatsy. I'm sure that tomorrow we will have a follow-up in part two to this. Both myself and the markets will have had a little bit more of a chance to digest all the signals coming from today.

So for now, we will wrap it there. Appreciate you guys listening or watching as always. And until next time, be safe and take care of each other. Peace. Thank you.