Graphing Digital Assets
Month in Review — August 2024
August came in with a bang as global markets were rocked by significant turbulence, primarily driven by the unwinding of the yen carry trade—strategies reliant on borrowing in low-yielding currencies like the yen to invest in higher-yielding assets—and deleveraging across several asset classes.
Signs of fragility began in July when rumored Bank of Japan interventions caused the yen’s depreciation trend to reverse, and traders began to close out short speculative positions (see graph). The turbulence intensified after a hawkish rate hike to 0.25% from the Bank of Japan on July 31 and as weaker-than-expected U.S. jobs data released on August 2 further unsettled markets. Investors reassessed the likelihood of a recession, which contributed to the sell-off in equities and the rapid unwinding of leveraged carry trades.
On August 5, speculative short positions in the yen were forced to unwind, sparking a broad market sell-off. The Japanese yen appreciated sharply, while global equity indices posted significant losses – Japan’s Nikkei and Topix indices plunged more than 12%, their worst performance since 1987, while the S&P 500 and Nasdaq dropped 4.2% and 6.3%, respectively.
The market turmoil extended beyond equities. Cryptocurrencies such as bitcoin and ether saw steep losses of up to 20% as traders faced margin calls that forced them to sell off their liquid positions. This highlights the interconnectedness of financial markets, where deleveraging in one sector can have ripple effects across seemingly unrelated assets.
However, recovery was swift. By the end of the week, major indices had regained most of their losses, and the VIX receded. Although markets quickly rebounded, the underlying risks driving the volatility have not been fully resolved. Many trades reliant on low volatility and cheap yen funding remain, and some of the more complex, illiquid positions are being unwound slowly. Meanwhile, signs indicate that new leveraged positions are being rebuilt, increasing market vulnerability. If these positions are unwound again during a period of heightened volatility, it could exacerbate market stress, leading to a negative feedback loop and further instability.
This episode serves as a reminder of the risks associated with highly leveraged trades, particularly in environments where volatility is subdued. The interconnectedness of global markets—extending from Japanese monetary policy shifts to U.S. economic data—magnifies the impact of such events on a wide range of assets, among them cryptocurrency and global equities.
The August Unwind
Sources: Investing.com as of August 31, 2024; Bank for International Settlements: BIS Bulletin No. 90 “The market turbulence and carry trade unwind of August 2024.” August 27, 2024.
To Fear or Not to Fear?
On August 5th, amid the global selloff, the Cboe Volatility Index (VIX) briefly soared above 65, marking its highest level since 2020, before the markets quickly stabilized, and volatility receded. Historically, September through year-end tends to exhibit heightened fear and volatility (see graph). This raises the question: Was the August spike a transient event, or a sign of what’s to come?
Here’s what the experts are saying:
Bank of America: The BofA data analytics team noted that "August fragility leads to fall volatility (and it’s not priced in)." This perspective suggests that the recent volatility spike might be a precursor to more sustained market turbulence as the year progresses.
Goldman Sachs: Christian Mueller-Glissmann, head of asset allocation research at Goldman Sachs, characterized the early August market downturn as a "warning shot," expressing concern over how quickly the market rebounded, which may obscure underlying vulnerabilities.
Bank of International Settlements (BIS): The BIS reported that, despite the speedy recovery, “the factors behind the volatility spike and large market moves have not changed significantly.” They note that the turbulence reflects elevated risk-taking and too much leverage which is likely to lead to further unwinding.
UBS: Gerry Fowler, head of European equity strategy and global derivative strategy at UBS, believes the volatility spike was a “huge overreaction” and expects volatility to settle higher than its current level, with markets likely trading within a range. Historically, declining nominal GDP, interest rate cuts, and uncertainty about the jobs market have led to increased volatility.
The underlying market conditions that led to the recent volatility surge suggest a complex landscape ahead. With significant macroeconomic data releases on the horizon, potential rate cuts by the Federal Reserve, and the upcoming election adding to market uncertainty, investors should prepare for continued fluctuations. The interplay of these factors could amplify market volatility, necessitating a cautious approach as we navigate the remainder of the year.
Source: VIX daily close data from Yahoo Finance. August 5th intraday reached a high of 65.7.
Spotlight on Digital Assets
The market’s attention in August was primarily focused on macroeconomic factors, yet there was plenty to report on digital asset activity during the month. Here are some highlights:
ETH Liquidations: While the broader digital asset market ended down in August, with BTC falling 8.73%, and altcoins, as represented by SPCLXM, seeing losses of 14.44%, ETH was hit especially hard, dropping 22.25% in the month. A significant factor in Ethereum's sharp decline was the massive liquidation of ETH. Major players, including the Ethereum Foundation and Jump Trading, were involved in the sale of approximately $600 million worth of ETH. Notably, Jump Trading added 88.9K ETH worth $276 million to centralized exchanges between July 25th and August 6th, which coincided with Ethereum’s 20% drop in early August during the broader global selloff, contributing to the market downturn. August Ethereum lending market liquidations were the highest seen since May 2021 (top graph).
August Report finds Singapore, Hong Kong, and the UAE to Lead in Crypto Adoption, Outpacing the U.S.: Singapore topped the index with a score of 45.7, thanks to its strong regulatory framework and initiatives like Project Orchid. Hong Kong followed with 42.1, aided by its advanced digital infrastructure and favorable economic conditions. The UAE scored 41.8, benefiting from its tax-friendliness and active startup scene. These regions have outpaced traditional crypto hubs like the U.S., which ranked fourth with a score of 41.7. The U.S. maintains strong innovation and technological capabilities but is hindered by its complex and restrictive regulatory environment.
BlackRock’s IBIT Sees $13.5 Million in Outflows: On August 29th, the top-performing U.S. spot BTC ETF by inflows, BlackRock’s IBIT, saw its second day of net outflows since its launch. While all other U.S. spot bitcoin ETFs have experienced multiple days of outflows, IBIT—leading in net inflows by over $11 billion— has only seen two. These outflows occurred as U.S. spot bitcoin ETFs collectively faced consecutive days of outflows from August 27 through month end (bottom graph), amid increased investor caution and volatility concerns going into September, which has historically been a downward trending month for the crypto market.
Post-Halving Consolidation Period + Expectations: Since March, the cryptocurrency markets have experienced months of sideways trading, widely seen as a consolidation period. This phase, marked by reduced speculative activity, is likely driven by ongoing uncertainties around digital asset regulation and broader economic conditions. Many traders are anticipating a breakout soon. One analyst pointed out that historically, similar consolidation periods following bitcoin halvings have lasted around 150-160 days and often lead to significant breakouts, suggesting potential market movement as early as September.
Source: The Block; Farside Investors. As of August 31, 2024.