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Why markets loose sleep over currencies going bump in the night

Flash crashes are developing into a phenomenon of behaviour in late-night currency trading, and while regulators are poring over what lies beneath them, bankers say the evolving architecture of the industry means further slip-ups are inescapable. Over the preceding few years, the so-called “witching hour” at the start of Asian trading has created sharp, vicious price swings hitting the New Zealand dollar, the South African rand, Sterling, the yen, and to a lesser extent even the Swiss franc. That growing list is getting heavier attention from policymakers around the world. Australia’s central bank indicated that the biggest recent mishap, which struck the yen on the first trading day of this year, left behind a stain on its own currency, moving the Aussie dollar to a 10-year low against the US dollar. Sterling’s sudden 10 percent drop over just 40 seconds in October 2016, meanwhile, prompted close scrutiny from the Bank of England. The headache is that the exchange rates reached in these events are not cleansed from trading systems. They remain, which means companies’ and investors’ hedging contracts or orders can be generated, periodically to their detriment. In a worst-case scenario, such violent moves could even threaten financial stability.

Given that the world’s foreign-exchange markets do not open or close through the trading days of the week, instead, they work from Monday to Friday. Over that long span, the start of the global trading day has consistently been mute. It is becoming obvious, however, that as machines have replaced humans, this quiet period has developed into a hazardous time. Traders, analysts and market intermediaries point to a variety of elements bringing about this spate of calamities.

Lower numbers of human traders trained at detecting and defusing unnecessary market shake-ups play a part, but the nature of their replacements also counts. Computer-driven algorithmic trading firms get out of the market when volatility spikes, traders say. Banks also often shut down their computers, which spew out prices in these market conditions. This tendency is expected to be permanent, given the pressure on banks to decrease the number of human traders following a wave of currency rate-rigging scandals earlier this decade. Certain market characteristics also exacerbate the pressure. Just as the market powers down after New York trading hours, Japanese brokers testr retail clients’ speculations, and close any that are threatening to push clients into negative balances.

Some also blame reforms begun after the 2008 financial crisis, which have required banks hesitant to accept on risk and operate as shock absorbers for markets. In moments of stress, machines shut down leaving it up to human intervention to stabilise markets as traders take the other side thus inhibiting the capacity for banks to be those circuit breakers.

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