Source: Wall Street See

Due to the closure of the $20 trillion arbitrage trade caused by the appreciation of the yen, the overseas stock market plummeted across the board yesterday.

Goldman Sachs analyst Paolo Schiavone believes that "the remedy must come from the source of the ailment" - only the Bank of Japan can prevent further deterioration of the global stock market.

Previously, several Bank of Japan officials appeared to appease anxious investors. Schiavone said that the exchange rate of the dollar against the yen reaching 130 could trigger central bank intervention, leading to a liquidity crisis.

When a crisis occurs, the central bank needs to intervene in the market urgently.

Goldman Sachs believes that the Bank of Japan has rich experience in quantitative easing, and implementing quantitative easing is not only to stimulate the current economy, but also to release more economic capacity in the future.

When an economic crisis reaches the panic stage, governments typically adopt large-scale monetary and fiscal stimulus measures in response. The monetary easing policy after the 2008 financial crisis is a typical example.

Quantitative easing and quantitative tightening are performed under different market conditions, which is why their effects may be asymmetric. Among them, the positive impact of quantitative easing is often long-lasting:

1. When there is a crisis, the central bank can stabilize the market by injecting liquidity:

When there are sudden trading shocks and frictions in the market, the central bank can take actions such as injecting reserves to alleviate these frictions or credit restrictions, thereby improving overall economic welfare.

2. Due to the lasting positive impact of quantitative easing, its results will not be reversed:

However, if the reserves injected are not withdrawn until these frictions and shocks dissipate, the previously positive effects will not be reversed because of this.

Goldman Sachs made an analogy: when the house is on fire, watering can extinguish the fire, which is beneficial to everyone. But when the fire is extinguished, draining the water will not rekindle the fire-the initial benefit will not be offset.

There is a big contradiction between the current overvalued Japanese stock market and the low interest rates in the currency market. If interest rates rise significantly, the stock market will face greater downward pressure.

We believe that the stock market is falling not because of an economic recession but because of the closure of about $20 trillion arbitrage trades.

Only the Bank of Japan can stop this situation, according to Goldman Sachs.

However, Goldman Sachs believes that the central bank's intervention is unlikely to quell the market this time:

Assuming that the inflation problem has been resolved, the central bank will first end quantitative tightening and then implement easing policies.

The arbitrage trade has cooled down, and the market is entering the late stage of the cycle.

Goldman Sachs believes that the yield curve indicates that the market is currently declining and entering the late stage of the cycle. The reasons are as follows:

1. Real interest rates have been high for 24 months.

2. Today's economy is overdrawing future economic growth.

3. Fiscal and monetary policies are being relaxed.

4. Valuations are in bubble territory.

Goldman Sachs expects that when the exchange rate of the dollar against the yen reaches 130, central bank interventions may be triggered. Currently, the exchange rate of the dollar against the yen is 145 yen.

However, central bank intervention may lead to a sharp drop in market liquidity, causing bigger market problems. But the possibility of a credit crisis is low, as many companies have already carried out refinancing, and interest rates are also dropping:

1. The current level of the US-Japan interest rate differential needs to be maintained for 6 months to trigger a severe market turbulence. The private bond market is already close to saturation, reducing the likelihood of market reactions.

2. According to expert predictions, the credit spread for investment-grade bonds may expand by 50-100 basis points, which is unlikely to trigger a more severe credit crisis.

Goldman Sachs believes that the current market conditions are extremely unfavorable. Due to high volatility, investors' interest in high-risk, high-return arbitrage trades has greatly weakened. In the next 3 to 6 months, investors are expected to continue to adopt a wait-and-see attitude.

Editor / jayden