Sun, Oct 09, 2016 - Page 15 News List

All eyes on robot traders following sterling’s plunge

The rapid sell-offs in foreign-exchange markets are happening more regularly and seem to be driven by algorithms

By Netty Idayu Ismail and Lilian Karunungan  /  Bloomberg

Making sense of the foreign-exchange market is Derek Mumford’s bread and butter, but he could not explain this.

In the span of just two minutes in early Asia trading on Friday, the British pound had plunged more than 6 percent, sending the fourth most-traded currency on the planet to the lowest level in 31 years.

Mumford, who advises companies on foreign-exchange and interest-rate risks, scrambled to find out why. There was talk of France’s president pushing for a hard-line approach on Britain’s exit from the EU and recycled rumors of a “fat finger” trade, but nothing that would justify a drop of this magnitude.

“It was out of proportion to the supposed trigger,” said Mumford, a director at Rochford Capital Pty in Sydney.

While he might never be able to pin down the catalyst for Friday’s drop, Mumford and many of his peers agreed that the sell-off was probably exacerbated by computer-driven traders reacting at speeds faster than any human could muster.

So-called algorithmic transactions in the foreign-exchange market have more than tripled over the last three years, accounting for about US$200 billion of daily turnover, according to Aite Group, a consultant in Boston.

That one of the planet’s oldest mediums of exchange — and the dominant reserve currency until the first half of the 20th century — could move like the legal tender of a frontier country is almost certainly to fuel debate over computerized traders’ role in the US$5.1 trillion-a-day global currency market.

Friday’s move in the pound follows a “flash crash” in the South African rand in January and a similarly unexplained move in New Zealand’s dollar last year.

“It’s one of these moves that we’re seeing more regularly,” said Hugh Killen, the Sydney-based head of foreign exchange, fixed income and commodities trading at Westpac Banking Corp, Australia’s second-biggest lender. “People are caught in a flash crash that does seem to be algorithmic driven.”

Fragility in foreign-exchange markets has been increasing even as “phantom liquidity” creates an illusion of stability, Bank of America Merrill Lynch strategists Chris Xiao and Vadim Iaralov wrote in a report on Wednesday.

The frequency and magnitude of “outsized volatility events” has also increased, they wrote.

While the pound’s intraday drop of 11 percent after Britain’s surprise vote in June to leave the EU was bigger than Friday’s slump, traders said this one was more jarring.

Not only did the crash happen in just two minutes, but nobody was expecting it. The move reminded several dealers of the reaction to the Swiss National Bank’s shock decision to abandon the franc’s cap against the euro in January last year, which sent the exchange rate surging more than 40 percent.

“This is the most volatile move seen from sterling since Brexit, yet it can be argued that relative to Brexit, this sell-off was more dramatic,” said Matt Simpson, a senior market analyst at ThinkMarkets in Singapore. “Nobody was prepared for it.”

Volumes in sterling are typically lower during Asian hours, but might have been even smaller on Friday given a dearth of market-moving news and a reticence to take positions before the monthly US employment report, Simpson said, calling it a “perfect storm for a price shock.”

While the flash crash might heighten concerns over the potential risks in markets where computers can execute hundreds of trades in an instant, there were few signs of contagion on Friday. The yen, a traditional haven during times of turmoil, was little changed.

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