In this episode of WuBlockchain Podcast, we once again discuss recent macro trends with Jiang Jinze, Chairman of MuseLabs, a global asset allocation research institution, and former Chief Researcher at Binance Research China. Due to Japan’s rate hike, global risk assets experienced a flash crash on August 5th. Jiang Jinze believes that this is not a typical crisis. He also argues that the current data is insufficient to support the view of a U.S. economic recession, so with the U.S. rate cut in September, there is a possibility of a rise in risk assets, including cryptocurrencies, in the fourth quarter. Ethereum’s trend may be similar to Bitcoin’s around the launch of the Bitcoin ETF. Transcript of the previous podcast: link

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Please note: The views expressed by the interviewee do not represent those of WuBlockchain. WuBlockchain does not endorse any products. Readers are advised to strictly adhere to the laws and regulations of their jurisdiction.

Is the Flash Crash on August 5th an Isolated Incident? Will it Happen Again?

When the event first occurred, there were many exaggerated headlines and interpretations in the market, such as claims of tens of trillions in liquidations. However, the funds involved in this event need to be viewed in two categories. First, the trigger was undoubtedly due to the unexpected reduction in bond purchases and interest rate hike by the Bank of Japan last week. Such an operation had not occurred for decades, so when it suddenly happened, the market reacted sharply. Many market participants had never seen anything like it in their entire careers.

In the context of ultra-low interest rates and the Bank of Japan’s long-term provision of global liquidity, the market had accumulated significant risks. Since Japanese funds had been flowing out to purchase high-yield assets like the US dollar, the market’s panic was understandable when this situation suddenly changed. This was particularly true in the context of a looming recession in the US, which intensified market volatility. This volatility did not only affect the crypto market but also global markets, with the forex market even seeing an unusual 12% rise in the yen in one day — a level of volatility not seen since the 1987 financial crisis.

It’s important to distinguish between short-term leveraged trades and arbitrage trades. One part of the market consists of trend-following leveraged positions, while another part involves medium to long-term arbitrage positions. The reactions and risks of these two are quite different. For now, it seems that medium to long-term arbitrage positions will not exit en masse, while short-term arbitrage positions have already been gradually digested following the event. In fact, from the chart of speculative net positions in the yen, it’s clear that the reduction in net short positions in the yen has been very rapid over the past two weeks, and the short-term panic over the yen has largely subsided.

However, will other medium to long-term arbitrage trades continue to pose risks? According to high-frequency data, as of August 5th, speculative positions in the yen have turned positive, and the likelihood of the yen accelerating its decline in the short term has greatly decreased. A 10% fluctuation in the forex market over a short period is enough to clear out all leveraged positions, so the market may have already created a “golden pit.”

For the stock market, the situation is more complicated because the stock market itself is a cash-flow market. Although exchange rate fluctuations affect the stock market, their amplitude is usually much smaller than in the forex market. Therefore, in this context, the forex market has become the core indicator for observing overall sentiment. As long as the downtrend in USD/JPY stops, the market’s panic should not intensify further.

Japan’s carry trades actually have a dual nature. On the one hand, domestic investors in Japan borrow yen at low interest rates to invest in high-yield assets overseas. On the other hand, some investors mortgage foreign currency assets to borrow yen for investment in domestic assets in Japan. Although yen appreciation may lead to losses in carry trades, the performance of the bond market shows that there has been no large-scale panic or withdrawal of market funds.

Thus, while the flash crash on August 5th was a significant event, it appears more like a short-term market fluctuation caused by multiple factors. Whether similar fluctuations will occur in the future mainly depends on the global economic environment and changes in the policies of major central banks. However, based on current data, the market has gradually digested the impact of this event.

The August 5th Incident Doesn’t Seem to be a Liquidity Crisis and Isn’t Worth Worrying About

Looking at the performance of government bonds and other markets, it seems that the so-called unwinding of yen carry trades has not really occurred, or if it has, it hasn’t been severe. This was more of a market reaction driven by emotional panic. Therefore, this incident doesn’t appear to be a typical crisis. If there had been a liquidity crisis, the US dollar should have risen, but in fact, the US dollar index (DXY) was also falling in the days before. If there had been a liquidity crisis, all assets, including stocks, bonds, and gold, would have fallen, but that wasn’t the case. Therefore, it could be judged at the time that this wasn’t an event of market panic, at least not for the big money players, who didn’t show signs of excessive panic.

This situation can be understood in two ways: On the one hand, the market might continue to fall until big money players begin to panic and withdraw, marking the bottom. On the other hand, the stability of these funds could also mean that the market might have already bottomed out. So in this case, each individual can develop corresponding strategies based on their positions and trading goals.

Further indicators show that this event is not worth excessive concern. Global fund inflows show that despite the market being in a correction state, global stock and bond markets have seen inflows over the past four weeks. Even if there has been a significant outflow in the money market, it may only be due to the withdrawal of arbitrage funds rather than a sign of market panic.

From the perspective of asset risk, both safe assets and high-risk assets have seen inflows, indicating that the market has not seen a large-scale flight of funds during the downturn. The changes in fund positions for different strategies, as tracked by Deutsche Bank, also show that the pullback in systematic strategy positions was very small, and the retreat in trend-following strategy positions wasn’t large either, indicating that market panic wasn’t high.

Overall, there is increasing evidence that the market is not in a state of panic. In the past two weeks, many institutional funds have shown an intention to bottom fish. Therefore, while short-term market panic has not completely subsided, it can be judged that this panic has already overreacted in the short term. As for the possibility of future rate hikes by the Bank of Japan, the recent statements from the Bank of Japan have shown some softening, and in the long run, such policy adjustments are unlikely.

Analysis of Arthur Hayes’ Latest Article

In fact, I saw that you compiled and distributed Arthur Hayes’ (known as “Xiao Hei”) article yesterday, which mentioned a balance sheet of the Japanese government. However, the data used in the article is not the latest, but rather data from two years ago. Nonetheless, this data can still be referenced to some extent. Some of the points in the article may be difficult for ordinary readers to understand, but certain parts are valid. For example, he mentions that the Japanese government promotes economic growth by lowering the liability side of the balance sheet, i.e., through low-interest financing. This is indeed true. If Japan were to raise interest rates proactively, it would actually be bursting its own bubble. Considering that the Japanese government’s balance sheet burden is extremely heavy (equivalent to more than five times GDP), increasing financing costs is unimaginable.

Arthur Hayes’ article mentions that the Japanese government is one of the largest participants in the market’s arbitrage trades. If rate hikes were to really burst all arbitrage trades, the first victim would be the Japanese government. Therefore, even after central bank officials released hawkish statements, the possibility of long-term rate hikes remains very low. I believe these hawkish statements are more bluster, and sure enough, the central bank soon changed its tone. In this context, concerns about long-term arbitrage funds returning are basically unnecessary because the Japanese government will not easily raise financing costs.

The Japanese government is not only engaging in arbitrage domestically but is also conducting a large amount of arbitrage overseas, with its foreign securities holdings accounting for about 50% of GDP, around $2 trillion. This means that the Japanese government and its subordinate institutions are conducting large-scale arbitrage overseas, and the scale of private arbitrage trades may be even larger. Therefore, this arbitrage model is unlikely to undergo a fundamental change in the short term.

Arthur Hayes’ article exaggerates in some parts, such as when he mentions that the scale of the Japanese government’s arbitrage trades reaches 505% of GDP. In reality, the right side represents the financing side, while the left side represents the asset side. Counting both as the scale of arbitrage trades is somewhat exaggerated. A more accurate estimate is that Japan’s foreign securities holdings amount to about $2 trillion, rather than the 200 trillion yen scale reported by some media.

Overall, although Arthur Hayes’ article is somewhat exaggerated, it still has some reference value for understanding Japan’s economic model and the structure of arbitrage trades. However, the “big collapse theory” in the article need not be taken too seriously.

Is There a Recession in the US Economy?

I believe that whether the US economy is in a recession may have different conclusions depending on the perspective. The media often likes to focus on changes in some new data while ignoring the stock data, which can easily lead to pessimistic conclusions. Bad news usually spreads faster, so if you rely solely on media reports, you might think that there are indeed signs of a recession in the US economy.

But from a comprehensive economic standpoint, the situation may not be that bad. First, according to existing economic data, the US manufacturing PMI (Purchasing Managers’ Index) has consistently underperformed due to the long-term hollowing out of US manufacturing. Labor skill levels are declining, and wages are rising, reflecting the plight of US manufacturing. Therefore, unless PMI shows a particularly significant change, relying solely on PMI to judge the economic situation may not be accurate.

More importantly, it’s essential to look at the overall economic performance. For example, the GDP growth rate for the second quarter in the US reached 2.8%, far exceeding expectations, indicating that economic activity remains strong. The expected growth rates for the next two quarters are 2.6% and 2.5%, respectively, also showing no significant signs of economic recession.

Moreover, price levels are gradually declining, inflation expectations are under control, and interest rates are expected to fall. Although the job market is not performing well, the unemployment rate has not shown a sharp increase.

Based on high-frequency data, overall economic activity this year is still in an expansion phase, and the economic index shows that most data is generally in line with market expectations. The financial conditions index shows that the market’s financing situation is not tight and has even loosened since June. Therefore, based on this data, the US economy does not support the judgment of a recession.

Currently, discussions about a recession in the market are mainly focused on manufacturing PMI and the unemployment rate. However, many classic macro indicators have failed in this economic cycle. For example, an inverted yield curve is typically a reliable predictor of a recession, but despite the US yield curve being inverted for two years, a recession has not occurred. Additionally, the contraction of the monetary base usually leads to a decline in market asset prices, but over the past two years, all assets in the US market have been rising.

In summary, although some indicators show signs of economic slowdown, overall, the US economy has not yet entered a recession.

The US Economy Has Not Recessed, But Why Is There “Recession Trading”?

Currently, relying solely on the unemployment rate to determine whether the market has entered a recession is not sufficient. Most data do not support the notion of a recession, but there are other reasons why “recession trading” is appearing in the market.

One important reason is that the market’s bets on big tech companies have become overly concentrated. In recent quarters, the financial data of big tech companies have consistently exceeded expectations, leading to market “aesthetic fatigue” towards these companies. The core of stock market trading is future expectations, and even if every quarter’s earnings exceed expectations, the market will gradually become picky, focusing on the degree of outperformance rather than the absolute value. When the market perceives that the degree of outperformance is shrinking, even if the earnings reports are overall good, funds may start to withdraw.

Before the second-quarter earnings season, market expectations for big tech companies were already very high. As a result, although the actual results still exceeded expectations, the margin of outperformance was smaller. This led the market to start reducing positions before the earnings season, especially investors like Buffett who began to withdraw funds in June, shifting to other areas. In this process, the market underwent a sector rotation, where funds flowed out of big tech stocks but did not flow into safe assets or fixed-income assets, instead moving into previously underperforming companies. This reallocation of funds does not indicate a decrease in market risk appetite but is part of a style rotation.

This flow of funds is not actually related to recession expectations. The decline in the stock market is more due to the heavy concentration in big tech stocks rather than a direct reaction to an economic recession. Therefore, linking the stock market’s decline to recession trading is somewhat misplaced.

For US stocks, continuous fund inflows are the norm, closely tied to the structure of the US economy. As long as Americans have consumption needs, companies can make money, and the US dollar will continue to flow into US stock and bond markets. Although this model may face challenges in the long term, in the short term, US bonds and stocks remain relatively safe investment choices.

Regarding big tech stocks, the current market sentiment has begun to reflect on the actual impact of AI technology. Many institutions are questioning whether AI can significantly boost productivity. Although AI seems promising from a technical standpoint, its actual contribution to corporate finances may be limited due to the open-source nature of large models and fierce competition. This reflection has also intensified the selling pressure on big tech stocks.

In conclusion, while the US economy has not entered a recession, the “recession trading” seen in the market is primarily due to concentrated positions in big tech stocks and adjustments in future expectations, rather than a direct reflection of economic fundamentals.

Will There Be a Massive Rally in Risk Assets After a US Rate Cut?

Personally, I believe there is indeed the possibility of a massive rally in risk assets in the context of a US rate cut, but it depends on the situation. If US economic data maintains its current trend without accelerating deterioration, then a rate cut would undoubtedly be a positive factor. However, the market has already priced in a rate cut for September, with the probability of a September rate cut exceeding 50% over the past two weeks and even reaching over 90% recently. Therefore, even if a rate cut is confirmed in September, the market’s reaction may not be significant.

Even with a rate cut of 25 basis points or even 50 basis points, the US risk-free yield remains around 4.8%. For assets without cash flow, like crypto, such a change in interest rates would not significantly increase their appeal. Therefore, rate cuts are more about influencing market sentiment than substantially boosting liquidity.

In this case, we need to closely monitor changes in market expectations and sentiment. If the rate cut in September exceeds expectations, or if the forward guidance from Federal Reserve officials shows a clear dovish tilt, it could lead to a more significant market rebound. If the rate cut is just the expected 25 basis points, and officials’ statements remain cautious, the market might be disappointed, and risk assets might not see a significant rally.

Moreover, if economic indicators suddenly take a sharp turn in the near future, showing signs of the US economy entering a recession, even a Fed rate cut might not benefit risk assets. In a real recession, simply cutting rates won’t reverse the economic downturn, and investors might turn to safer assets, such as defensive stocks or bonds.

In summary, the impact of a Fed rate cut on the market will depend on economic data and market sentiment. If the rate cut is seen as a sign of increased confidence in the economic outlook and the rate cut exceeds market expectations, risk assets could see a massive rally. However, if the rate cut is merely symbolic, accompanied by cautious forward guidance, the market reaction might be relatively muted. Lastly, it is important to keep a close eye on statements from Fed officials to understand their latest views on market sentiment and the economic outlook.

Why Has Ethereum Been So Weak, and What Is the Future Trend?

Currently, Ethereum’s weak performance is actually very similar to Bitcoin. The market experienced a rise before the official launch of the Ethereum ETF, but due to the relatively sudden timing of the ETF launch, the cycle of speculative trading was shorter. This is different from the long period of speculative trading around Bitcoin last year, resulting in Ethereum not fully benefiting from the favorable macro environment. The launch of the ETF lacked the “right time and place,” leading to a relatively limited rise in Ethereum.

Additionally, during this rise, Ethereum faced selling pressure from Bitcoin. Several unlocking events in the Bitcoin market, as well as sales by the government and bankrupt institutions, led to negative market sentiment, which suppressed Ethereum’s gains. After the ETF listing, both Ethereum and Bitcoin experienced a “sell the news” situation, where the market fell after the positive news was confirmed. The selling pressure from the Grayscale unlocking further exacerbated Ethereum’s decline.

Looking ahead, Ethereum might replicate the previous trend of Bitcoin. During the initial stage of the Bitcoin ETF listing, although the price fell, Bitcoin eventually rebounded as the market gradually digested the selling pressure and net inflows increased. Therefore, Ethereum’s future trend may also depend on the Grayscale unlocking and other ETF subscription situations. If we see a shift in Ethereum’s fund flow to a long-term net inflow, market sentiment might gradually recover, driving Ethereum prices to rise.

Moreover, there may be some misunderstanding regarding expectations for ETFs. Although the launch of ETFs has garnered widespread attention, the growth rate may not be as fast as the market anticipates. Actual data shows that ETF growth has already been very rapid, with IBIT holders now including 615 institutions, indicating that there is still great interest in ETFs. Therefore, despite Ethereum’s recent weak performance, in the long term, as the market matures and capital continues to flow in, Ethereum’s price is likely to strengthen.

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