Mysterious pound rout spotlights robot trades
Making sense of the foreign- exchange market i s Derek Mumford’s bread and butter, but he couldn’t explain this.
In the span of just two minutes in early Asia trading on Friday, the British pound had plunged more than six per cent, sending the fourth most-traded currency on the planet to the lowest level in 31 years. Mumford, who advises companies on foreignexchange 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 European Union, and recycled rumours of a “fat finger” trade, but nothing that would jus- tify a drop of this magnitude.
“It was out of proportion to the supposed trigger,” said Mumford, a director at Rochford Capital in Sydney.
While he may 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 computerdriven 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 almost 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- trilliona- 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 an Oct. 5 report. While noting that traditional liquidity indicators including bid-ask spreads have narrowed, they said one measure of the market impact for any given trade has climbed by 60 per cent since 2014.
“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 Think-Markets in Singapore. “Nobody was prepared for it.”
It’s too early to come to a conclusion about the role of algorithmic traders in Friday’s rout, said Ralph Achkar, capital markets product director at Colt, which provides trading infrastructure to electronic dealers.
“We have come across several market incidents where the initial finger was first pointed at algos, only for it to turn out to be human error or otherwise,” Achkar said.
A Bank of England spokesman said the monetary authority is looking into the cause of the crash.
There was some confusion over how low the pound actually fell. Bloomberg’s composite price — which takes the median contribution from a range of dealers — showed the currency dropping as low as US$1.1841.
IT WAS OUT OF PROPORTION TO THE SUPPOSED TRIGGER.