It shows how scarred the FX market remains over liquidity
levels when what would historically be a normal move makes people nervous.

This morning in very early Asia, Cable was sold steadily
down from its open in New Zealand at 1.2480 (my sources tell me the first trade
was actually someone buying at 1.2484 – they’re not seeing that for a while!)
to 1.2430.

All very normal and nothing to get excited about you would
think (and you’d be right), but then it kept on going and accelerated down to
1.2400 (I believe the low is 1.2394), and it is that 1.2435-1.2395 move that
triggered the nervousness.

Sources tell me a second wave of selling at 1.2430-40
prompted a widening of spreads from markets makers and a thinning of the depth
of book, helping exacerbate the move lower.

The reason for the move appears to be a front page story in The Times discussing “concerns” within
the UK government that the Scottish government will use the triggering of
Article 50 as an excuse to call for another referendum on independence.

In such circumstances a 90-point drop in Cable seems
appropriate – the article is part speculation (on the part its sources, not the
paper) and part a reflection of the probability of a second Scottish
referendum.

The widening of spreads reflects the nervousness felt by
many liquidity providers over pricing Cable in early Asia – it has not escaped
people’s notice that the move today occurred just after 10am Sydney time (it
was actually around 10.25am), before Asia is up and running, which means there
are definite echoes from October 7 when the flash crash occurred at 10.07am
Sydney time.

One outcome of the events of October 7 has been banks
increasing their human presence in markets during illiquid hours. I am told
that several institutions have increased the number (and in some cases
seniority) of staff coming in early in Singapore to monitor markets and one –
Citi – is actually in the process of moving its Asian spot desk to its Sydney
office.

This would seem to be a sensible solution because so many of
the moves in this small window between the New York close and the
Tokyo/Singapore open are event driven. The echoes between this morning and
October 7 resound even further when one considers a press article was (wrongly
in my view) believed by some to be behind the flash crash, and another article
triggered today’s selling.

The fact is, UK papers publish either side of midnight and
that falls right in the illiquid window. So having human resources to make a
judgement will actually help markets react proportionately to these events. As
an example, I had two interactions this morning, one was with a hedge fund
trader who told me about the Times
story, the other, a minute or two later, was with an e-FX trader at a bank who
had no idea it was out – their liquidity provision models were responding to
price action alone, hence the widening.

It is in closer interaction between human and machine that
the future has to lie if the FX market is to remain a fundamentally stable
place. Yes, moves will happen, as I argued in Thursday’s column FX markets have
historically accurately reflected economic fundamentals, but with greater human
interaction in the process they are less likely to get out of hand for no
reason. If nothing else, the human trader/oversight will be able to let the
e-team know what news story is out, what it says and what the likely longer-term
reaction is going to be.

The key to having this sort of structure in place also means
having the appropriate risk profile, however. It’s one thing to have people in
the right place but if they are handcuffed their usefulness is diminished.

I sense a more positive approach to risk within the banking
industry, although it is very much a nascent trend – if indeed it is a trend at
all. It is to be hoped that the trend continues, for the authorities clearly
want little to do with averting flash events, therefore it is, again, up to the
industry.

A crucial element in rebuilding confidence in FX markets’
ability to handle surprise events remains a better, more robust, depth of book.
We have excellent market making technology in the industry, this will only be
better utilised if it can have quality data, more depth, and less flash moves.

Confidence starts from within.

Colin_lambert@profit_loss.com

Twitter @lamboPnL

Twitter @Profit_and_Loss

Colin Lambert

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