I will make the formal apology on behalf of Profit & Loss for this publication’s role in England’s demise at the World Cup in this weekend’s In the FICC of It podcast, but for now, I am writing this in the hours following Croatia’s victory and therefore – in spite of them probably deserving it on balance – please forgive me if I descend into bitterness!
Today’s column is loosely linked to Monday’s as I thought the price action in Cable around the resignations of four government ministers that day was quite illuminating regarding how the modern foreign exchange market operates.
When the news first broke (on Twitter) Cable dropped around 30 points, bounced 10 and then dropped maybe 15-20 lower – in other words for a government in such strife the reaction wasn’t exactly over the top – there are those of us who remember when such events were good for a 300 point move at least. As I have acknowledged before, however, we exist in different times.
At first I just thought it was another case of Asian traders highlighting the challenge facing the region as it tries to reinforce its recent growth and associated efforts to become a seriously meaningful FX centre, by not really reacting and waiting, as they so often do, for Europe to come in.
The reality was different, there was some genuine uncertainty about whether to buy or sell sterling on the news, which I have to confess I find confusing in itself (and indeed the market is trading some 120 points below where the news broke, but, as always it didn’t go in a straight line!) So we have what most rational minds would think is the right outcome – a weaker pound on uncertainty around the (minority) government – it’s just it took so long. It is a real paradox that as FX trading has become faster, so the playing out of fundamental moves seems to get slower.
Partly this is because of the lack of risk takers globally, hedge funds looking at currency are doing OK, but not blowing the doors off, and elsewhere? Well really we have a bunch of people trying to make money out of “inefficiencies” (which normally involves arbitrage and last look!) or we have retail traders who are eager to grab any gain going. What is missing from times gone by is the bank risk takers.
Talking to people in the bank e-FX trading space they stress the fact that typically they are risk assumers, not risk takers – in other words, they choose which customer business to hold and what not to (normally based upon historical performance analytics and not an appreciation of the current market environment), and even when they do hold, it’s not for long.
This means that unless they do get a surge of customers selling, they themselves are unlikely to sell – it’s another instance of banks becoming brokers in the FX world, which is not itself new. I recall attending MFA conferences back in the first years of this century when hedge fund managers on panels routinely referred to banks as “brokers”.
This is not to say this is necessarily a bad thing, it is merely the reality of the current market. The interesting thing for me is how you judge the absence of these traders on market quality. On one hand you can say that their presence could easily exacerbate a move and therefore their absence makes markets more stable, but on the other, these people are often a circuit breaker when markets go a little haywire.
There is little doubt that the short term risk model has dampened volatility, as has the growth of the retail punter who wants to take a profit when they see one, and this has brought us to a new market paradigm where the market either doesn’t move much on unexpected or unscheduled events because either the big risk takers aren’t there or people are quick to take profit…or they move a huge amount and no-one stands in the way of the runaway truck.
Although I know certain authorities would like their cake and eat it, they have the choice between a generally quieter market with fewer 200 point moves on fundamental shifts in the political or macro environment, but more flash crashes; or they accept a busier day-to-day market, with less, or no, flash events. It’s an intriguing question and I would be keen to hear views on it – I think I know where I stand but it is yet another grey area when it comes to the market structure.
I did want to highlight one very positive outcome from Monday’s price action – my sources tell me that depth of book was good, and this also helped to dampen volatility following the resignations. There are clients out there who do not care about market direction or timing, they care about being hedged and, occasionally, the level at which this occurs, and their orders are in the public market.
This is hard evidence of the impact of both the internal reviews at banks following the chat room scandal, as well as the implementation of the FX Global Code. LPs, typically the banks, are now putting their customers’ orders into the public market, rather than hold them themselves. This is creating a depth of book and the sources tell me that often in a mean reverting market these orders are filled, the market bounces back, and the bank concerned has a very happy customer. This is a positive of the Global Code and the push for segregated order books or desks – the lack of discretion means that customers get fair fills, and the public market gets more liquidity (and data) to feed off.
I do have to note, of course, that it didn’t take too much messaging to find a player with a story to tell of a customer complaining about a fill at 40, for example, when the market dropped sharply to 20, but some people just can’t be pleased (the market probably bounced back above their level as well!)
One cynic did suggest that one of my Tweets hit the nail on the head on Monday morning in Asia – I may have suggested that no-one try to sell Cable using an algo, we know what happened last time – and that people were genuinely afraid of triggering another flash crash; I don’t buy that, however.
Whichever way you look at it, the entire event gave an interesting insight into how things work now. Even if you are a trader who likes to trade in the direction of the news you have either to be in it very quickly and for a very short time (and in size) or you have to have patience (and a strong constitution occasionally). The latter has all the characteristics of a trend follower, but as results seem to show, this strategy rarely works well these days.
We hear a lot about machine learning nowadays and it would be interesting to see if this process picked up on these nuances in the market when picking a strategy. I am doubtful, for it seems to me that any time computers are part of the decision making process, logic dictates taking the easiest route to profit. In today’s FX market that is see a gain in the short term and take it, and then reset. It may not be a bad strategy, but it is radically different to that used two decades or more ago.