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Mini flash crash sees Swissie on the slide

6:40 pm, 11th February 2019

On 6 May 2010, as Britons were going to the polls in an election that would ultimately lead to the creation of the first coalition government since the Second World War, the New York Stock Exchange suffered its worst one-day fall in decades.

It began at just after half past two in the afternoon on Wall Street and, within ten minutes, the Dow Jones Industrial Average had lost 9% of its value with a plunge of more than 1,000 points – sufficient to wipe more than $1tn from the value of US stocks.

The index clawed back most of the losses by the close.

Or maybe you recall the flash crash that hit the pound in October 2016.

Sterling, already rocking on its heels after the sell-off four months earlier that followed the vote to leave the EU, fell by more than 6% against the US dollar in a matter of minutes.

At one point, it fell to as low as $1.145, a level not seen since February 1985.

Today, the foreign exchange markets saw another “mini” flash crash, this time hitting the Swiss Franc.

It fell by around 1% against both the US dollar and the euro at around 10pm on Sunday evening – although it has since recovered most of those losses.

The similarity with the flash crash that hit sterling in 2016, though, is interesting.

Both happened when the US and Europe were shut and both have been blamed on a lack of liquidity.

In 2016, the sterling crash happened at 1am UK time, when most FX trading is taking place in Tokyo or Singapore.

Trading in “cable” (the sterling-dollar “pair”) tends to be subdued at that time of day anyway and with a number of bank holidays taking place in the region, including in China, it was quieter than usual.

The same ingredients were in place today.

Trading in the Swiss franc tends to be quiet in the Asian markets and, in addition, Tokyo was shut for a holiday.

So there were fewer market participants around than usual.

There, the similarity ends, as the fall in the pound in 2016 was more dramatic than today’s one affecting the Swissie.

Moreover, while the drop in the pound remains unexplained – the Bank for International Settlements, the so-called “central banker’s central bank”, investigated the fall, but struggled to explain its cause – today’s fall seems to have been caused by human error.

What is especially striking, though, is that this is the second flash crash to have happened in the FX markets this year.

A similar sell-off, on 3 January this year, saw the Japanese yen rocket by 8% against the Australian dollar and by 4% against the euro in just a matter of minutes.

Again, there were similarities with previous flash crashes.

Some market participants believe sterling’s fall in 2016 was triggered by a speech by the then French president, Francois Hollande, that indicated the EU would play hard-ball with Britain in the Brexit negotiations.

Sterling wobbled on that news and the fall was then accentuated by automated “black box” or “algorithmic” traders whose strategies are based on high-speed computer programmes and mathematical formulae.

The yen’s sharp surge was thought to have been prompted by Apple’s profit warning that night, which was based on weakness in Chinese sales, sparking concerns about the strength of the Chinese economy.

One way to trade that weakness would normally be to sell the Australian dollar, as the strength of Australia’s economy is closely linked to that of China’s, while at that time of the day the obvious “pair” for the Aussie – and a natural safety play under such circumstances – would be the yen.

The initial trades were done by humans but, with trading volumes light as Japanese markets were still closed for new year holidays, the black box traders quickly took over to accentuate the falls.

The euro, it seems, was caught in the crossfire and also fell due to it being a proxy for Germany – whose exporters depend heavily on Chinese markets.

Also affected that night was the Turkish lira, a currency beloved for trading against the yen, which fell by more than 10% against the Japanese currency at one point.

The chances are that there will be more of these flash crashes.

Human traders are becoming increasingly scarce in some markets, notably in interest rate products, while ‘algos’ are becoming more common.

Most of these black box traders are programmed not to hold positions over the long term but make a profit by firing off hundreds of orders per second and making a very modest profit on each one.

That means, where there is a dramatic move in a security, they will move quickly to close their positions and this can exacerbate falls.

Today’s drop in the Swissie, meanwhile, will have brought out some nostalgia among human traders.

One of the biggest swings in the FX markets in recent years that can genuinely be ascribed to human beings, rather than computers, came when, in January 2015, the Swiss National Bank abandoned a policy of pegging its currency to that of the euro.

The value of the Swissie rocketed against the single currency by nearly 30%.

This latest drop was not nearly so spectacular – although, for anyone who was awake and active in the markets at the time, it may have been a fantastic opportunity to buy one of the globe’s great ‘safety play’ currencies more cheaply than usual.