In such a historic year – for it has been that – it feels
appropriate to have an Accolade dedicated to the shock of the year. I should
point out this is a market shock – not the kind felt by much of the world as
the US presidential election results unfolded.
The obvious candidate is sterling post-the EU referendum,
after all it’s not every day you see a 17 big figure move, but in my mind
(which is obviously a little warped), this didn’t count as a shock. It was a
rational reaction to a political event and the subsequent weakness accurately
reflected the uncertainty that lies ahead for the UK.
So if it can’t be that, then perhaps it’s events surrounding
the US election? After all it was a little chaotic and confusing. I watched the
dollar plummet, yen gain strongly and Mexican peso collapse in a heap before
retiring for the night – only to wake up the next morning and not only find the
moves reversed (except for the peso) but actually in the other direction!
That was a “what the…?” moment in my year certainly, and it
was characterised by the move in AUD/JPY which at least allowed me to rant
about how we ignore cross influences in a world gone crazy with correlations.
This cross fell 6% in a few hours and then rebounded 7.5% in the next 24 and it
drove a lot of activity in USD/JPY – but I was still subjected to suggestions
that the USD/JPY move was being driven by oil, stocks, in fact everything
except for AUD/JPY which was seeing massive flows from Japanese retail
I know analysts are well paid and feel the need to justify
it sometimes, but often these moves are simply explained. There is a simple
correlation that says if everyone rushes into (and out of) a cross, the legs
will see plenty of action.
Anyway, somewhere in the carnage of that election there was,
again, some rationality to the moves.
Another obvious candidate for this Irrational is the Cable
flash crash on October 7, which was, obviously, unprecedented in the scale and
speed of the move.
But…I think one of the reasons we are not hearing horror
stories from this event – unlike SNB Day which dominated last year’s
Irrationals – is because the move was down. Against a background of a market
nervous about the prospects for the UK economy and the pound – and at a time of
day when sensible people are sitting on their hands waiting for Asian markets
to open properly and get slightly better liquidity – someone slammed Cable and
at the same time the market was not particularly short.
Put simply, most people expected something to kick sterling
lower at some stage. I don’t personally believe it was a news reading algo – if
it was it had some serious latency because the FT headline and move were over a minute apart – but notwithstanding
that, if there was going to be a move it was widely expected to be lower.
For the winner of the “What the…” Moment of the Year” then,
I return to the night of the UK referendum but not to sterling.
It is widely recognised that USD/JPY is, outside of EUR/USD,
the most liquid currency pair in the world. More to the point it has a central
bank that is, in all seriousness, intent on watching the market carefully and
committed to a stable market.
In a matter of seconds on June 24 in Asia, as the UK results
rolled in, USD/JPY fell from over 105 to 99.10, and then rebounded to 103 and
then 104. It really was a “blink and you’ll miss it” moment and I have to
confess I had to go back and check the rates were genuine and that I had
actually seen them.
I had. And it happened. The second most deep, most
liquid, market in foreign exchange had just suffered a mini-flash crash (and I
like how it can accurately referred to as ‘mini’ – for much of the past 10
years it would have equalled a quarter’s range!) and the only people that
probably noticed were those stopped out.
If the FX market structure is robust as some still like to
claim – this type of move doesn’t happen. In some emerging market currency
pairs yes, in USD/JPY, no.
Flash moves are the result of reluctant market makers to
a) ?a) Make
a rate in anything but the minimum amount
b) ?b) Market
makers pulling out for a variety of reasons but in banking terms, capital and
c) ?c) The
lack of resting orders in the market from customers reluctant to trust their
order with a third party
d) ?d) The
lack of pre-positioning on the part of investors and traders
e) ?e) Obsession
with top of book and ignorance of some best execution policies to recognise
that sometimes – just sometimes – it’s better to keep things quiet
f) ? f) The
unintended consequences of regulation
g) ?g) All
of the above
The Code of Conduct may help solve some of these issues but
not all and the fundamental problem that faces the market is the lack of
incentive. The risk-reward equation is heavily biased towards risk when it
comes to a banker for example, making more rates, in larger amounts and holding
I am not sure how we solve this problem if I am honest, but
the solution is going to be the key to a recovery in market conditions.
Foreign exchange services the real economy and as such it is
a vitally important cog in the global economy, so removing the fear factor –
actually making it OK again for someone to make a (non-conduct related) mistake
in the right spirit – and actually incentivising people to try to innovate is
the only way we rebuild a stable, professional, orderly and trustworthy market.