Crypto market’s ‘perfect storm’ can lead to further massive capitulation

On Aug. 2, $2.9 trillion vanished from the stock markets, resulting in the worst day of trading since the COVID-19 crash in 2020. Mounting recession fears and other factors have also plunged the crypto markets, flooding the sentiment with fear. 

Bitcoin (BTC) has dropped by 27%, Ether (ETH) by 34%, and more than $1.13 billion in futures positions have been liquidated. The last-day market action has dramatically changed the Fear & Greed Index from greed (74) to fear (26), very close to extreme fear. 

The CBOE Volatility Index (VIX), which measures stock market volatility based on S&P 500 index options, reached 65, the highest level since the pandemic crash. This indicates that markets could enter an extreme turbulence phase. The reasons for this downfall are not crypto-specific but clearly affect Bitcoin and especially the altcoin market. 

On Aug. 5, 2024, during an emergency analyst call, Maximiliaan Michielsen, a financial researcher at 21Shares, highlighted the potential drawbacks of the crypto market’s unique 24/7 trading availability. He noted that “crypto was the only asset that was traded all over the weekend,” making it the sole tradable asset as the adverse events unfolded.

What is driving the recent sell-off, and how have markets changed so drastically? Recent market data reflects widespread skepticism about the ability of global policymakers, particularly the US Federal Reserve, to curb inflation without inflicting significant collateral damage. Additionally, many conditions need to be factored into the equation.

The markets believe a recession could hit the US economy

On Aug. 2, the US nonfarm payrolls report showed a steep slowdown in hiring in July, with employers adding just 114,000 payrolls instead of the expected 175,000. With this new data entry, the Sahm Rule—developed by former Fed economist Claudia Sahm—hit 0.53%, according to Fed data, surging from 0.43% in June.

The Sahm Rule is designed to detect recessions as they begin, not as they unfold. A recession signal is triggered if the three-month moving unemployment rate average increases by 0.5 percentage points or more from its 12-month low.

The indicator has successfully identified the onset of every recession in the US since 1970. Therefore, the markets could have understood this latest data entry as a possible sign of an upcoming recession and acted accordingly. 

Claudia Sahm explained to Yahoo Finance that the tool was created so that others would notice when to take action. Despite the negative signal for a recession, she believes that “there is a runway, and we are not in that danger zone yet.”

The sudden market upheaval has led numerous market participants and economists to advocate for an emergency rate cut by the Federal Reserve. Jeremy Siegel, an economist and finance professor at the University of Pennsylvania, has called for a 75-basis-point rate cut, with a subsequent 75-basis-point reduction expected at the Federal Reserve’s September policy meeting.

Japan’s yen carry trade sell pressure

A significant factor behind this abrupt market shift is the Bank of Japan’s (BOJ) decision to raise its interest rates for only the second time since 2007. Though modest, at just 0.25% from its previous range of 0% to 0.1%, the BOJ’s increase has been enough to prompt a notable reaction in global markets.

Since the 1990s, Japan has experienced persistent stagflation, characterized by simultaneous rises in unemployment and inflation. To stimulate the economy, the BOJ set interest rates to nearly 0%, which created a conducive environment for arbitrage, known as the carry trade.

Under these market conditions, a prevalent strategy involved borrowing money in yen, converting it into dollars, and investing in assets like stocks, real estate, or cryptocurrencies to earn higher returns. The key to this carry trade was achieving a yield greater than the borrowing interest rate. When executed wisely, this strategy could effectively turn into almost free money, leading many traders to adopt it.

Japan’s recent interest rate increase sets a new precedent for future adjustments, potentially aligning with the trend of other global central banks implementing record-high hikes. While some traders may have managed to sell their positions in time to secure gains, many market participants may have been forced to sell in a panic to cover their operations.

Traders facing significant losses and margin calls are selling their US stocks to raise US dollars and convert it back to Japanese yen to be able to pay back their loans. This sudden change in forex trading can lead to more selling pressure on US stocks or cryptocurrencies in the short term. 

Disappointing US tech reports reignite fear of potential AI bubble

The latest data on the US economy, combined with shifting global forex conditions, has coincided with disappointing results from tech stocks. Technology shares, which have been a leading force in the US market, represent 42% of the S&P 500 index, a benchmark tracking the performance of the top 500 US companies.

On Aug. 1, Amazon fell 9% after the e-commerce giant reported weaker-than-anticipated quarterly revenue. Intel stock plunged as it announced a $10 billion cost reduction plan that would lay off 15% of its workforce. 

Despite positive revenue reports from companies like Meta, Apple or Nvidia, tech stocks have been adversely affected, suggesting that investor concerns extend beyond earnings results. This has reignited fears of a potential AI stock bubble, further intensifying market anxiety and contributing to increased sell pressure.

Investors resort to cash with geopolitical tensions

Geopolitical tensions have been affecting the markets since the Russian incursion into Ukraine in 2022. Nevertheless, the markets have progressed despite the turbulence. However, the latest tensions between Israel and Iran have made the market fear a possible greater war in the Middle East.

The last time that Iran attacked Israel was on April 15, which was in response to Israel’s attack on an Iranian embassy in Damascus, Syria, Following the attack, the price of Bitcoin nosedived as the world shook with the uncertainty of a possible war between both countries. There is a fear that a war between these archenemies could escalate into a broader global confrontation, given that the US is a staunch ally of Israel, while Russia and China have strategic alliances with Iran.

​​The extent of other countries’ involvement will hinge on their willingness to directly engage in the conflict. Nonetheless, a regional conflict in the Middle East could have widespread collateral effects, particularly on nations involved in oil production, potentially impacting global markets.

Leena ElDeeb, the research associate of 21Shares, noted in an analyst meeting that despite Bitcoin’s narrative as a safe haven, it does not consistently fulfill that role. 21Shares views BTC as an emerging store akin to gold; however, ElDeeb mentioned that during crises, like the current sell-off, “people don’t resort to gold; people resort to cash,” which can extrapolate to Bitcoin’s price. 

Bitcoin price correct expected to intensify

All these conditions exert pressure on all markets, including the crypto markets, where money is converted into cash. The popular analyst Rekt Capital, believes Bitcoin’s price downside may last for two months before a new bullish chart pattern could emerge to a breakout. 

As for its price range, the analyst told Cointelegraph to prepare for price levels close to $40.000:

“At its lowest point, Bitcoin dipped below its 50-week moving average. Without strong buyer support right now, it goes even lower, and it would trigger an even more active sell-off as it did in late 2021 and early 2022. If it doesn’t hold either, it’s worth preparing for a failure toward $42,000.”

A perfect storm appears to be brewing in the crypto market, with participants needing to take a broader perspective and stay attuned to macroeconomic events that could potentially steer the market back into positive territory.