Crypto remains on edge. That could be bad news for the stock market

Crypto had a rough November. The pain is persisting into December — and that could signal trouble ahead for the stock market.

Bitcoin has slumped 7% in the past 24 hours, sliding from just below $92,000 to roughly $85,000 as of Monday midday. The cryptocurrency sold off sharply late Sunday — tumbling more than $4,000 in just a few hours — as December trading kicked off in Asia.

Bitcoin has seen intense swings in recent weeks as risk-off sentiment has spread through markets. In addition to a risk-averse mood, the latest freakout in the crypto world stems from concerns about the unwinding of a popular trading strategy.

So, what’s going on?

The Bank of Japan has signaled it could raise interest rates at its policy meeting later this month. That is throwing a wrench into a trading strategy that relies on borrowing relatively cheap Japanese yen.

For years, a lucrative trade for global investors has been to borrow yen to buy high-yielding assets like US stocks, or in this case, cryptocurrencies. Interest rates in Japan had been low or at zero, making borrowing yen relatively cheap and creating a sweet opportunity for traders. It’s known as the “yen carry trade.”

However, the Bank of Japan has signaled it could raise interest rates, in part to address stubborn inflation, continuing a recent shift away from years of ultra-low rates. Yields on benchmark Japanese bonds just hit their highest level since 2008, signaling expectations for higher rates. As rates in Japan rise, it can boost the value of the yen. That makes borrowing yen less affordable, eating into the profitability of the carry trade.

That could pressure traders to sell their bitcoin and stocks now to repay their loans and prevent the risk of further losses. In addition to a sell-off, it could lead to less cash flowing into crypto and stocks.

“This raises questions about the unwinding of the yen carry trade … which would drain liquidity from the system,” Matt Maley, chief market strategist at Miller Tabak + Co, said in a note. “That would not be good for the stock market.”

US stocks were slightly lower Monday: The Dow fell 200 points, or 0.42%. The S&P 500 fell 0.18%, and the tech-heavy Nasdaq Composite fell 0.14%.

For crypto, the sell-off has been widespread: Ether, the world’s second-largest cryptocurrency by market value, has tumbled almost 10% in the past 24 hours.

Bitcoin’s tumble comes on the heels of a steep sell-off in crypto markets just weeks ago. Bitcoin in late November fell to just above $80,000 — down roughly 35% from a record high above $126,000 in early October.

The slide in bitcoin led stocks lower and, in particular, the tech stocks that had been carrying the market. The S&P 500 fell almost 5% at one point in November before rallying and slighting gaining for the month. The tech-heavy Nasdaq posted its first losing month since March.

Markets are “not out of the woods quite yet,” Maley said.

“The renewed decline in bitcoin could create some real problems for the stock market,” he said in a note. “If the issues which are creating this decline do not subside, the year-end rally scenario will run into some real headwinds.”

In a sign of the risk-off mood, investors are again piling in to gold and silver, which are considered safe havens amid uncertainty. The price of silver hit a record high on Monday as investors scooped up the metal, which can be considered a cheaper alternative to gold. Silver prices have doubled this year, and have also been boosted by increased industrial demand.

Proponents of bitcoin say volatility is part of the journey. Meanwhile, critics say bitcoin is falling short of its proposed use as a store of value, given its susceptibility to intense fluctuations. Bitcoin is now down roughly 9% this year, while the S&P 500 is up roughly 16%, and gold is up 61%.

All things considered, the S&P 500 is less than 2% below a record high set in late October. December is a historically strong month for markets, and Wall Street is leaning in to bets that the Federal Reserve will cut interest rates this month, which could boost stocks. However, more volatility could be in store as bitcoin languishes more than 30% below its record high and nerves linger about the yen carry trade.

“With all of this in mind, we’re still at a key juncture for the stock market,” Maley said. “The developments out of Japan are creating some uncertainty about a year-end rally … so the ‘all clear’ flags are not flying high just yet.”

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