Are flash-crashes the future?
Photo: Ostephy. Source: Morguefile
We’ve seen flash-crashes in stocks and in bonds. It’s inevitable that they should spread to other asset classes.
Early this morning the British Pound fell by over 6% in a few minutes. The exact magnitude of the fall is unclear, because the currency snapped back so quickly. One pricing service had it as low as 1.13 to the dollar, after opening the day around 1.26. It quickly came back to 1.23, a modest 2% drop. Over the past year, though, the Pound is down 20%.
British Pound vs. US Dollar, 10-6-16 through 10-7-16. Source: Bloomberg
Nothing really justifies a drop of this magnitude. There has been some talk of Europeans taking a hard line against the UK in Brexit negotiations, but nothing to justify this level of volatility. In the past several years “flash crashes” have become more common, often linked to Exchange Traded Funds and algorithmic trading. This is the first one that has involved the currency markets.
It’s unnerving when one of the world’s major currencies can move so dramatically. Over $6 trillion trades daily in the global currency market, facilitating trade, investments, capital flows, and other economic purposes. That’s a significant proportion of the global economy. This is a deep and liquid market. By contrast, stock trading on all US exchanges totals about $270 billion per day.
Photo: Katrina Tuliao. Source: Trader Group
This is possibly a result of robo-traders entering the foreign exchange markets as large financial institutions withdraw from currency dealing. Partly as a result of the Basel III capital rules and partly because of the forex price-rigging scandal, big banks like Citi and Barclays aren’t as active as they used to be. As they’ve pulled back, new trading firms have moved in—Citadel Securities, Global Trading, and Jump Trading, among others. These algorithmic market-makers aren’t supporting correspondent banking services or large corporate clients. They can pull out of a market as quickly as they enter. And as we’ve seen recently, this can exacerbate the trends and lead to breathtaking volatility.
This is not your father’s forex market. Cable and Swissy swaps aren’t limited by the speed of a trader’s fingers or the breadth of their trading blotter. It’s a brave, new world, that hath such algos in it.
Douglas R. Tengdin, CFA
Chief Investment Officer