According to Peter O’Flanagan, head of foreign exchange trading at Clear Treasury: “There is no doubt we’ve entered a period of higher volatility and we are seeing this across equities, commodities and currencies. Daily moves in excess of 1-2% have become the norm and prudent management of risk exposures is key for investors to weather this period.”
MORE DISORDER
This year has also been punctuated with more sharp spikes in currency volatility than would typically be expected because of what Wood-Collins says are the “unintended consequences” of market change and reforms.
Among the most significant events this year was the abandonment on 15 January of the Swiss National Bank (SNB) policy of capping the Swiss franc’s value against the euro, which resulted in the largest recorded one-day movement (18%) of a major currency pair since the advent of floating currencies in 1972.
Two months later, the overnight (London time) reaction to remarks made by Federal Reserve chair Janet Yellen on 18 March, which were taken to indicate that US interest rate rises were more distant than the market had anticipated, caused the US dollar to weaken against the euro by approximately 4% in overnight trading, before recovering almost to its prior level.
And, on Monday 24 August, around the time of New York opening in highly volatile equity markets, the Japanese yen spiked upwards against the US dollar by about 3% and the euro similarly surged about 11.2%.
The reasons for the August spike are less clear, but some experts believe that when the New York equity market was opening on that Monday, such was the scale of the downturn in Asia that US equity futures contracts opened ‘limit down’ (at the lowest price permitted by the circuit breakers).
“Traders were therefore unable to short equities further, and apparently shorted the US dollar against the yen and euro as a crude risk proxy trade, with the dollar seen as having risk on characteristics and yen and euro as safe havens,” explains Record’s Wood-Collins.
The scale and prevalence of currency ‘events’ has raised concern in many quarters and points to a market that is less able to absorb shock movements in foreign exchange.
The Bank of England, in its Quarterly Bulletin Q1 2015, points to several factors having contributed to what it called the “disorderliness” following the SNB’s decision to drop the euro peg. Electronic platforms, it says, have become more prevalent in FX markets, accounting for over 50% of all spot currency trades, according to the Bank’s data. Once the SNB announced its decision, electronic platforms were switched off “as quickly as possible” as some dealers withdrew quotes in all currencies. “It only required one or two of the large players to switch off their electronic platforms for liquidity to disappear altogether, given the close interlinkages in the foreign exchange market,” the Bulletin says.
The growing number of transaction venues has also been blamed for the increased sensitivity of FX markets to shocks by creating what Record’s Wood-Collins calls the “ liquidity mirage”. “While liquidity across these venues appears to have increased,” he says, “these venues are sharing the same underlying liquidity.”
Regulation of banks has also had an impact, not just as the increasing capital requirements result in less capital for trading desks, but also as fewer experienced dealers inhabit those desks as the old guard has cleared out following regulatory investigations. The relative lack of both experience and appetite to hold risk has made it harder for banks to absorb shocks.
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