Why the rand has been hit by ‘flash crashes’

Eruptions of volatility have occurred to a growing number of currencies in the past few years. They have one thing in common – the timing of the outbreaks has been uncannily similar.

For market watchers, the period in the global trading day between the close in New York and the open in Tokyo has become known as the witching hour when thin liquidity exposes financial markets to rapid swings.

In January 2016, South Africa’s rand tumbled as much as 9% in minutes, while the pound plummeted 6.1% in a few frenzied minutes in October that year.

Add the yen to the list now.

If liquidity was thin in those past incidents, it was even worse on Thursday with Japan shut for the last day of its new-year holiday break.

Orders to dump the Australian dollar and the Turkish lira against the yen rapidly spread to other crosses as algorithm trading kicked in. Within minutes, the haven asset was surging against every foreign exchange tracked by Bloomberg.

“There’s been some poor investor positioning,” said Tano Pelosi, portfolio manager at Antares Capital in Sydney. “It’s partly to do with liquidity. But the big risk-off moves escalated throughout December, and it takes time for the ultimate investor to change their strategic positioning.”

Flash crashes

Flash crashes have become more of a hazard for markets as regulatory limits to risk-taking by banks since the global financial crisis spurred them to trim inventories.

As a result, when a sudden flood of orders hit screens, market makers are less able to fulfill demand, leading to pricing spikes. To reduce exposure, some investors have taken to cutting positions ahead of holidays.

Thursday’s volatility isn’t isolated and investors should brace for more swings, said Tuan Huynh, chief investment officer, Asia Pacific, at Deutsche Bank Wealth Management in Singapore.

“We have pointed this out to our clients that more and more of these algo trading are coming up, so you have to be prepared for these kind of trading patterns,” said Huynh. “We saw it last year in the equities space two times, and before that also once or twice a year.”

One-week implied volatility for the dollar against the yen jumped to the highest since February, while that for Aussie-yen surged to the most since April 2017.

In the space of seven minutes from 9:30 Sydney, the Japanese currency gained almost 8% against the Aussie, while also surging 10% against the lira. Traders reported losses as they struggled to cope with the extent of the move.

More price gyrations may be in store this year during Asia’s witching hour, particularly with uncertainty ranging from the US-China trade war, developments in Brexit, and the global stock rout, analysts said.

“If you’re going to put money on the table, then steep volatility is to be expected for a while,” said Jingyi Pan, market strategist at IG Asia Pte. in Singapore.

“If you’re in and ready for big swings, this is likely to continue for a bit – otherwise this is a time for risk aversion.”


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Why the rand has been hit by ‘flash crashes’