Due to the appreciation of the Japanese yen leading to the unwinding of a $20 trillion arbitrage trade, overseas stock markets collapsed across the board yesterday.
Goldman Sachs analyst Paolo Schiavone believes that &#34;the one who tied the bell must untie it&#34;: only the Bank of Japan can prevent further deterioration of global stock markets.
Previously, several Bank of Japan officials came forward to reassure investors. Schiavone stated that an exchange rate of 130 USD to JPY could trigger central bank intervention, leading to a liquidity crisis.
<h2>When a crisis looms, central banks need to intervene urgently</h2>
Goldman Sachs believes that the Bank of Japan has extensive experience in quantitative easing, which is not only to stimulate the current economy but also to unleash more economic capacity in the future.
During times of economic crisis reaching a panic stage, governments typically implement large-scale monetary and fiscal stimulus measures to cope. The monetary easing policy after the 2008 financial crisis is a typical example.
Quantitative easing and quantitative tightening are conducted under different market conditions, which is why their effects may be asymmetric. The positive effects of quantitative easing are often long-lasting:
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1. When a crisis strikes, central banks can stabilize the market by injecting liquidity:
When there are sudden trading shocks and frictions in the market, central banks can alleviate these frictions or credit constraints by injecting reserves, improving overall economic welfare.
2. Due to the lasting positive effects of quantitative easing, the results are not reversible:
However, if reserves injected are withdrawn only after these frictions and shocks dissipate, the previous positive effects will not be reversed.
Goldman Sachs made an analogy: when a house is on fire, pouring water can put out the fire, benefiting everyone. But draining the water after the fire is extinguished will not reignite the fire—the initial benefits are not offset.
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There is a significant contradiction between the overvaluation of the current Japanese stock market and the low interest rates in the currency market. If interest rates rise significantly, the stock market will face considerable downward pressure.
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We believe that the decline is not due to an economic recession, but due to the unwinding of approximately $20 trillion arbitrage trades.
Only the Bank of Japan can prevent this situation.
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However, Goldman Sachs believes that the problem this time is that central bank intervention is unlikely to calm the market:
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Assuming the inflation issue has been resolved, the central bank would first end quantitative tightening and then implement an easing policy.
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<h2>Arbitrage trades are unwinding, and the market is entering the late stage of the cycle</h2>
Goldman Sachs believes that the yield curve indicates that the market is in a recession, in the late stage of the cycle. The reasons are as follows:
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Real interest rates have been high for 24 months.
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Today's economy is borrowing from future economic growth.
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Fiscal and monetary policies are easing.
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Valuations are in bubble territory.
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Goldman Sachs expects that when the USD to JPY exchange rate reaches 130, it could trigger central bank intervention, with the current rate at 145 JPY to USD.
<img src="https://imageproxy.pbkrs.com/https://wpimg-wscn.awtmt.com/ee50cda4-b6db-4efd-af4e-edfab69fb971.png?x-oss-process=image/auto-orient,1/interlace,1/resize,w_1440,h_1440/quality,q_95/format,jpg" alt="" original-src="https://imageproxy.pbkrs.com/https://wpimg-wscn.awtmt.com/ee50cda4-b6db-4efd-af4e-edfab69fb971.png"/>
However, central bank intervention may lead to a sharp decrease in market liquidity, triggering larger market issues. The likelihood of a credit crisis is low, as many companies have already undergone refinancing, and interest rates are also decreasing:
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The current spread between US and Japanese interest rates needs to be maintained for 6 months to trigger severe market volatility. The private bond market is already close to saturation, reducing the likelihood of market reactions.
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According to experts' predictions, the credit spread of investment-grade bonds may widen by 50-100 basis points, which is unlikely to trigger a more serious credit crisis.
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Goldman Sachs believes that the current market conditions are very unfavorable, with high volatility leading to a significant decrease in investor interest in high-risk, high-return arbitrage trades. Over the next 3 to 6 months, investors are expected to continue to adopt a wait-and-see attitude

Goldman Sachs believes that in a high-interest rate environment, there is a risk to market liquidity. If the USD/JPY exchange rate reaches 130, it may trigger central bank intervention. Currently in the late stage of the economic cycle, central bank intervention may not be very effective

Goldman Sachs: Only the Bank of Japan can save the market?