Transcription
Hello everyone, a short private video today so we can talk about the Japan Carry Trade. It's something extremely important because on Thursday evening, we will see the Bank of Japan's decision on whether or not to raise its key interest rates by 0.25 points, which would take them from 0.5 to 0.75, and that hasn't happened since '95. So we'll need to look at what the consequences of such behavior could be. We also need to price in the scenarios that will be good for us, as well as bad, in the short and medium term, and especially talk about the unknowns, because there is one major unknown.
We will redefine what the Japan Carry Trade is, but just before we define it, the unknown is still a significant one: we don't know how much money is represented by this carry trade problem. We don't know if it's 500 billion, if it's 1 trillion, 2 trillion, 4 trillion, or even more. And so, this is a real problem. You will understand why.
What is the Japan Carry Trade, in essence? Well, you know because you watch a lot of videos, we've already talked about it. In fact, it's about taking advantage of a situation where there's a country with a very loose monetary policy, meaning key interest rates are close to zero, and credit interest rates are also zero. And essentially, you borrow money at zero interest and you invest it elsewhere where there are higher yields and interest rates, and you pocket the difference.
So, Japan, where the situation has been very stable for a long time, has a policy that is very much in favor of economic expansion. There's a huge debt relative to GDP, so they don't have much choice but to have monetary stimulus after monetary stimulus. And this has offered a 30-year horizon where, between 0 and 0.5% key interest rates, most of the time at 0%. And so there's a kind of free money mechanism where people say, "Well, the baseline is that Japan will never raise its rates. I can borrow at zero interest. I can have repayment agreements that aren't month-to-month, year-to-year, but more like bonds, where I borrow for 5 years and repay the principal in 2, 3, 4, or 5 years directly, and in the meantime, I pay zero interest."
So, the mechanism is very simple. For example, if you have risk aversion, you buy, or rather, you borrow money at zero interest, and you invest it, for instance, in a US Treasury bond, not a stock, but a bond, specifically a 1-year Treasury bill, which currently yields 3.55%. And a little while ago, it was even higher, around 4.3% or 4.4%. And you pocket the difference: 4.4 - 0 = 4.4 for you. All this while being invested in an asset considered extremely safe. So, that's the Japan Carry Trade.
And the problem right now is that, naturally, the Bank of Japan has said they might raise rates, and we need to know what the consequences will be. So, there are two possible consequences. One, in which I believe much more than the other, and it could potentially lead to short-term turbulence and a more or less positive response for us in the medium term. We'll discuss it now.
So, as I was saying, the big unknown is that in this Japan Carry Trade, we don't know how much money has been borrowed from Japanese banks to be used in this free money mechanism. We don't know if it's several hundred billion, several trillion. And that presents a first unknown because, naturally, the effect if we enter the pessimistic scenario won't be the same if there are sales for, say, 400 billion, as if there are sales for 3 trillion. That's not the same thing. So, naturally, that's the first significant unknown.
What's simply happening now is that investors will have different choices. The choice isn't so much based on yield, but rather on the exchange rate difference between the dollar and the yen. Why? Because you have a mechanism currently that is as follows: the Japanese bank raises rates. So, the yen will appreciate. The yen will appreciate, and not against any currency, it will appreciate against the dollar. Let's look at the chart right here.
Here we have the dollar against the yen, which has been historically strong for a very long time. If we again enter a configuration like the one we have now, with a Fed that is lowering rates, a dollar that will decrease in value, and conversely, a yen that will appreciate, then naturally, you will have an exchange rate difference that can be problematic. You borrowed in a currency that was very weak, and when you have to repay, the currency against which you exchanged assets in the US market depreciates, and you will have to convert back to yen to repay your loan, and so mechanically, you will lose on the exchange.
Let's take an extremely hypothetical example that isn't even accurate, just to illustrate. Between the time you took money in yen, put it in dollars, and when you repay, the yen has appreciated by 10%, and the dollar has depreciated by 10%. The exchange rate difference is enormous. So, what's happening now is asking: will investors react by saying, "Well, we don't know if the Bank of Japan will raise rates significantly. What we do know is that the Fed will lower its rates and continue to do so." So, wouldn't we sell all our assets now to repay our yen loans? That's a first possibility that doesn't seem to be taken into account because the two markets with a lot of liquidity from the carry trade are not only the bond market, and we see that yields aren't necessarily rising. So, if yields aren't rising significantly, it means these bonds aren't being sold heavily either. So, it's not really there that it's happening.
Where it could be happening is in assets that offer much higher yields, particularly technology stocks. So, we can think of the Nasdaq, we can think of various individual company stocks. AMD, Tesla, Nvidia, for example, all these big companies that are in a super bullish trend, there's no problem. They have a small retracement. We don't know if it's the start of a bear market or not, but in any case, they might say, "Let's sell to repay, so that in case of exchange rate differences, we're covered." Because you need to understand one thing: exchange rate differences, you might say, "Well, it's not huge overall," but don't forget that people are leveraged. People are leveraged; we see it with this chart here; leverage has never been used so much and been so high.
So, all these people who took money that was considered free, well, tell yourselves one thing: if they're exposed to 10 billion, will they say, "Well, it's so safe, why wouldn't we take leverage x3, x4, x5?" And so, naturally, with all this money, the exchange rate difference can lead to consequences where portfolios drop by -10%, -15%, -20% in a few weeks.
Now, we know the market always prices in advance what will happen, and for now, we don't see that it's being priced in. Why? It could be at different levels. The Japan Carry Trade narrative, we've heard it a billion times. So, maybe people, it's a bit like Trump's tariffs. The first time, it caused an uproar, it caused panic, but the second time, people say, "Well, this always resolved well, so this time it will resolve just as well." That's a first hypothesis.
Second hypothesis is that indeed, everyone present in the tech market says, "Well, there's also a mechanism to appreciate, and that's why the hypotheses are numerous and the consequences very difficult to anticipate: they might say, 'Okay, very good, the yen will strengthen, but we borrowed money at zero interest, very good, we're beyond that.'" And what is the Fed's policy? The Fed's policy is precisely to lower rates, to restart QE, and we know that will be bullish for risk assets. So, why wouldn't we stay not in the bond market, because rates will fall, we see the direction they're taking, they're following a direction similar to interest rates. So, if currency rates fall, yields will also fall. We also know that the Fed will buy quite a few Treasury bills, mostly T-bills. So, short-term yields, well, we know: buying means bonds will rise in price, yields will continue to fall. So, it's not in this market that we should be exposed, at least with carry trade money. Where we should be exposed are assets that will yield more, so notably risk markets.
So, will their behavior be to say, "We sell everything and go back to yen," or will their behavior be to say, "We are greedy, we see that there's a policy that is becoming much more accommodative. We're pricing in that it will give momentum to the market, that it will go higher." And so, not only do we keep our current positions, but we also liquidate our positions here, here, here, to rebalance the money. Now, we have more yield. So, these are different hypotheses. We don't know if necessarily 100% of actors will follow hypothesis 1, hypothesis 2, or be split between the two. Naturally, we don't know, and that's the unknown we're navigating. That's a first hypothesis.
Second hypothesis is that naturally, a Japanese policy that is accommodative means that the yen will suffer. The Nikkei is the Japanese stock market index for the 225 largest listed companies. This market is worth 6 trillion. So, it's priced in yen, naturally. So, if the yen appreciates, you know how this market works. Normally, I stress normally, we'll see at least a correction starting. And so, will the US market, which is also very often correlated with the Nikkei and vice versa, will the US market also suffer a little with positions being exited everywhere, or will actors also say, "Well, we're accommodative in Japan, we're accommodative in the US, so let's exit our money from the Nikkei for the Japanese there and invest in the US market." So, there can be these dual mechanisms that we need to pay very close attention to.
What we also know is that the Japanese are a bit resentful of the United States since the tariff war. We saw it together. Japan and the United States have been extremely close economically, militarily, culturally, everything you want, since the end of World War II. So, there's a great friendship between the two, and the Japanese are a bit annoyed by what Trump did with his tariffs and everything. So, we could also have a narrative where the Japanese, who have a lot of honor, say, "Well, let's also look out for ourselves a bit more." And looking out for themselves means raising rates a bit to tell the Japanese, "Come back, because the yields are starting to be a bit better here. Bring your money home. Stop putting it elsewhere." That could be one thing.
A second thing that could also happen and would lead to a mini-catastrophic scenario in the very short term is that Japan starts massively selling T-bills, notes, bonds, because it's the largest holder of US debt. And so, we would find ourselves in this catastrophic scenario where a lot of money is leaving the US markets to repay debt in yen. We also have Japan selling US debt and T-bills and so on. I continue to believe that the Fed's action was also to liquidate banks, that's for sure, we've seen that before, but also because they're starting to realize that all these government bonds, which are being neglected by almost everyone, will need to be bought back.
And so, if this happens starting Thursday or next week, because you know markets: very good news, generally markets react first by falling then rising. Bad news: strangely, they rise for a few days and then crash. So, if indeed we see bad news on Thursday evening, meaning they raise rates to 0.75%, that asset prices start to rise a bit, etc., in key zones that we'll see in a future video, or in Thursday's live stream, then we'll need to be careful. We'll need to be careful, we'll need to manage our positions, and potentially do something painful, like reducing the portfolio by 50%. That is, exiting 50% of positions entirely, regardless of the loss level, because if the catastrophic scenarios happen, it's a plunge that can be extremely sharp due to panic selling, margin calls for the second wave, and so on. So, we'll only know this from Thursday evening, at 10 PM. So, I encourage you to stay awake until then and watch what happens.
And of course, there's the scenario where, indeed, all this doesn't happen because we're pricing in that a 0.25% increase isn't enough. The yield spreads are still sufficiently large, which is the case, let's not lie, and that all of this is already priced in as not catastrophic. So, that's why we'll set stop-losses for 50% of the portfolio if it happens, but only if there's a 0.25% increase. If it doesn't happen, it will be a good surprise, so there's no reason to set them. If it does happen, we'll set stop-losses, but we'll look at the levels directly on Thursday evening. So, be connected. That's for the short term. That's for the short term.
And this narrative could clearly lead to what we experienced in 2020, a kind of Covid 2.0. We remember 2020; there was the same narrative; there was bank liquidity stress first, then Covid brought the big flash crash, huge panic, margin calls everywhere, liquidation of all positions, and the Japan Carry Trade could indeed bring about an impulse just as strong, but limited in time. Why? Because naturally, massive money, panic movements, government bonds being sold means the Fed will have to intervene to respond to that. And to respond to that, there could be a clear and definitive return to a very loose monetary policy, with rates falling immediately. Even Japan could do a U-turn, because it has already happened in the past that Japan raised its rates and then lowered them directly in the following two months because they saw it caused a catastrophe. That's also why I think they will consider these hypotheses, because it has already happened. They've seen the effects on the economy and they've done a U-turn directly. So, they're not foolish either. They have statistical data, they have past data to rely on to see what will happen in the market.
But in any case, if it happens, it will be a flash crash. It will be a flash crash for a few weeks, maybe even 3 or 4 months, regardless, until everything stabilizes. But this will clearly cause a huge pivot point in the Fed's policy. And so, the market will be divided into two levels. There are those who will want to put 50% of their portfolio into stop-losses and who will want to bet on a big drop, because we have levels, and we'll see on Thursday, key accumulation levels for Bitcoin, that's for sure. But again, if the Nasdaq drops as it did here, if it drops by -30%, don't think that the levels on Bitcoin will hold; they won't hold. So, there are those who will say, "Well, I'm betting on a more or less violent drop, and even if I realize 50% of my portfolio with current losses, buying back lower will smooth out the average purchase price much lower, so either way, we'll be winners."
And there are those who will say, "Well, I don't necessarily need that. I'm willing to wait a month and a half, two months for a flash crash, a policy reversal, and then precisely a super cycle that is launching, because that's entirely possible." Let's recall, the 4-year cycles are specific to cryptocurrency because it's a young market. Tomorrow, it tends to follow much more what the stock market does. And you can see, if we take the Nasdaq from its low here in 2015, we didn't experience a bear market before 2022. What we experienced were flash crashes. Flash crashes of several weeks in 2018 and 2020, but otherwise, we've been bullish, and after these small recessionary moments, there wasn't a year-long bear market. We had that in 2022, but since then, we've only had small corrections, or even big corrections, but very rapid in terms of time, and we recovered. And this is truly the destiny of cryptocurrency, the destiny of Bitcoin, to follow movements that are much more volatile in the very short term, but not movements like this that last a year, a year and a half. For me, that won't happen for a while before we have a truly mega crisis that screws everyone over for two years.
So, that's what we're seeing right now. We'll see on Thursday where we stand regarding positions. There are those who will play, how to say it? There are those who will play this hypothesis again. We won't sell blindly, betting that it will happen. We'll set stop-losses. So, if the stop-losses are hit, it means it's happening. And on this, there are three hypotheses.
First hypothesis: the stop-losses are not hit. And that is, how to say it? That's positive for us. The stop-losses are not hit, we go much higher. Well, great, that's positive and it's okay.
Second hypothesis: the stop-losses are hit. And therefore, we go much lower. And if we go much lower, then naturally, that's also positive because we will have smoothed out our average purchase price.
The only hypothesis, and I stress the only hypothesis, where it wouldn't be positive is if we set stop-losses, the stop-losses are hit, and the market does something that it can totally do: reverse and go directly up without going much lower. And then it will be problematic. That will be the only hypothesis where playing this correction would not have been a good move.
Now, if it happens, for me, if the stop-losses are hit and it goes lower, it means it goes lower like this: a flash crash directly for a few weeks, caused by panic movements. So, we'll talk about it a bit more on Thursday. We'll see where we are because there are key levels. We need to see what the price does between now and then because the big players aren't foolish; they anticipate a lot of things, and we see that currently they're not necessarily anticipating this. So, we'll see the reasons.
In any case, understand this video well, watch it twice, three times, ask questions in the Discord, via private message, but preferably in the general channel, except for group 2. Well, in the group 2 channel, and I'll respond to that. The Praetorians will answer all your questions if there are any misunderstandings. But this is what we could have ahead of us. So, I know it can be annoying; we know it now; we repeat it: markets, we react to what we see, we react to what we see, and unfortunately, we are subject to the news that reaches us. So, yes, it's annoying; we were planning something else. Okay, very well. Well, listen, in August, we didn't know there would be bank liquidity stress. We learned that with data releases afterward. It also happened because of the government shutdown. We couldn't anticipate that. So, we react to what's happening. Now, we have a new narrative emerging that leads to different hypotheses. Hypotheses that can be very positive, others that are very unhealthy, and so we react by trying to escape the unhealthy hypotheses.
So, so, again, I repeat: there's no obligation to set stop-losses for 50% because what we're considering is, again, if it goes wrong, but I'm making an effort to repeat so that at least we have the summary of the summary: if it goes wrong, it's a flash crash. It's not a bear market; it's a flash crash, which would be met with a very positive response from central banks, including the Japanese one, and a reversal like this. So, no obligation to set them. There are those who will want to play it, those who won't. Everyone is free to do so, but in any case, we'll have an update on Thursday to discuss it. Have a good day everyone. Bye. Bye.