FX flash crash has ominous overtones

By Swaha Pattanaik

(The author is a Breakingviews columnist.)

LONDON, Jan 3 ( Breakingviews) - The foreign exchanges used to be as close to a perfect market as could be expected outside of economic textbooks. That is less and less the case. Wild lurches on Thursday saw a range of currencies suddenly slump against the yen. There have been other short sharp shocks in the last few years in a market where daily turnover tops $5 trillion. But this time the gyrations were more widespread. Changes to the way banks behave in response to regulation mean such jolts will become more frequent and less contained.

As in previous crashes, there was little to justify such big moves. Concern about the health of the global economy grew after Apple on Wednesday cut its sales forecast, citing slowing iPhone sales in China. Flows into the safe haven of the yen gathered momentum and stop-loss orders, which are designed to limit investors' losses, were triggered. The growing army of computer-driven traders probably also exacerbated the gyrations.

Over a decade ago, there would have been plenty of people willing to take contrarian positions to mitigate such wild moves. But post-crisis regulation has clamped down on proprietary trading in banks and forced them to hold more capital against trading exposures, making them less able to use their balance sheets to hold positions, even for short periods of time. This shift to a so-called agency model, where they are basically acting as agents for clients, from what was primarily a principal model means there are fewer players willing to step in when currency lurches are bigger than justified.

That is a problem for companies or investors who need currency trading for real business purposes, rather than mere speculation. The less efficient the forex market becomes, the more they will have to live with wild and unexpected swings.

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- The yen surged against other major currencies on Jan. 3. Concern about the health of the global economy, particularly China, drove investors to the safe haven of the Japanese currency. Its rise gathered momentum after the break of key technical levels triggered more sales and forced investors to unwind some of the large bets they had previously placed against the yen.

- The dollar fell as far as 104.10 yen, its lowest since March 2018 and 4.4 percent weaker than opening levels. The greenback was trading around 107.70 yen at 0850 GMT on Jan. 3. The yen also rose sharply against the traditional high-yielding currencies that are favoured by Japanese retail investors. These currencies include the Australian dollar and the Turkish lira.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

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