Article / 07 October 2016 at 5:01 GMT

3 Numbers: GBPUSD flash crash will have consequences, maybe for policy

Blogger / MoreLiver's Daily
  • The sudden GBPUSD crash won’t be forgotten and will impact markets
  • UK data could help lift GBP closer to yesterday’s levels
  • IMF and World Bank meetings: Draghi speaks on Saturday
  • ECB chief Mario Draghi apparently favours banking mergers and acquisitions
By Juhani Huopainen

After last night’s developments, I decided to write about the GBP, today’s UK data releases and this weekend’s annual meeting of the International Monetary Fund and World Bank. Obviously, the main data release today is the US jobs report, but I have previewed it in a separate article (US jobs preview: Solid report expected with December rate hike looming).

On top of all this, there will be four speakers from the Federal Reserve today, all of them after the jobs report: Federal Open Market Committee members Stanley Fischer (1430 GMT), Loretta Mester (1645 GMT), Esther George (1900 GMT) and Lael Brainard (2000 GMT).

 Today's industrial production for August release will give some guidance on the real direction of the UK economy, and show whether the optimistic results of surveys are valid. Photo: iStock

The flash crash

After the wild moves in GBPUSD on Thursday night, apparently on no news in particular, the usual US jobs-report drama might be secondary to seeing who got hit by the flash crash and how badly. This kind of move without proper news driving it suggests to me that somebody was holding an exotic FX option – probably a GBP put with a down-and-out barrier.

While the put option was profitable clearly above the barrier level, reaching the barrier level immediately expired the option as worthless. Thus, someone had a strong interest to push the market lower at slow Asian hours, triggering sell stop-orders on the way down and eventually reaching the barrier level. Market manipulation in the FX markets is legal, mind you.

While the exact nature of the event is unlikely to become public knowledge, it will surely create a lot of conversation and perhaps even some policy changes. The key question is whether certain instruments should be banned. Focus will shift to instruments that are prone to create market discontinuities and provide little or no economic benefit to market participants.

This means exotic options with discontinuous payoff profiles will soon probably be frowned upon. As banks are dependent on good terms with their respective regulators and central banks and investors’ appetite for “speculative” banks is small, banks will probably self-regulate this. They will have to, because FX trading margin rates are so small that either such derivatives are cleaned out, or the whole architecture of the markets will have to be redesigned around these derivatives. I believe it is a no-brainer to assume that the derivatives will have to go.

Investors will probably continue closing the gap between the flash crash level and prevailing levels right before the plunge. GBPUSD was slightly above 1.26 before the flash crash, but given the downward bias of the exchange rate, investors will probably not push the rate back to yesterday’s levels, so 1.2500-1.2550 could become the post-crash high.

One-minute candlestick chart for GBPUSD; from 1.26 to below 1.10?

Chart source: Saxo Trader. Create your own charts with SaxoTrader; click here to learn more.

While there have been flash crashes in other markets, the FX market has remained relatively void of such issues. The importance of timely and valid markets for currencies is very important – GBP is not some penny stock that should be allowed to be hit by a fat finger or a devious market manipulator.

Given the GBP’s recent weakness, perhaps today’s economic data from UK will be watched a bit more closely.

Fore more on the flash crash of the pound, please see: Flash crash of the pound baffles traders with algorithms being blamed, Sterling slumps as support levels crumble in thin Asia trade,and 'Fat-finger' error seen as sterling slumps; Asian shares dip.

Zoomed-out GBPUSD hourly chart (shows three months and the latest breakdown)
GBPUSD hourly

Chart source: SaxoTrader

IMF and World Bank annual meetings

The International Monetary Fund and the World Bank hold their annual meetings this weekend in Washington, D.C. The message from the IMF to the world leaders have targeted especially Europe – recapitalize and consolidate the banking sector, increase fiscal spending where it is possible and introduce structural reforms.

European Central Bank president Mario Draghi will be holding a press conference on Saturday. He has recently asked for the governments to do more –  and if they won’t, the ECB would be forced to do more, he has remarked earlier. Draghi also seemingly wants to see a clean-up of Europe’s banking sector preferably by mergers and acquisitions. There are too many banks in Europe without a viable future.

Most likely the world leaders will agree that more needs to be done, but actual policy measures and announcements will have to wait until the December central bank meetings and the official Brexit announcement in the first quarter are out of the way. The closer the policy announcements will be to the important elections in France and Germany, the better it will be for the mainstream parties.

Looking at the early statements, I doubt that a consensus will form yet around increased fiscal spending and fixing the banks. It seems the politicians are more interested in blaming the populists. Germany’s finance minister Wolfgang Schaeuble complained on Thursday that “people don’t trust their elites”. To me that sounds that he still doesn’t understand that the elites had their chance, and they created the European Monetary Union, didn’t control current account balances or banks and have failed to provide and execute a road map out of this mess. The more they complain about the populists, the more populists will grow. It is the elites that are populists, but they don’t get that.

Maybe the “elites” will also recognize that their words and policy stances can have a real impact. The recent bashing of Britain has perhaps gone too far. We’ve been told how crazy Britain was to leave the EU, and how a mutually beneficial deal cannot be made, because the EU would unravel as other members would also want to leave. Maybe the leaders will tone down their talk, because volatility in one part of the market tends to spill over to other parts as well. Hard Brexit talk could bite back at the strictest speakers.

 UK data expectations

Today we will get the September Halifax House Price Index (0730 GMT). The expectation is that month-over-month prices remain unchanged – a sign of stability – but would still be 5.8% higher than a year ago.

The August Manufacturing Production (0830 GMT) and Trade Balance (0830 GMT) are among the relatively few important data pieces to be released shortly. The purchasing manager indices and the GBP-weakening already provide guidance on the direction of the economy. Still, a confirmation of the rosy surveys by real data is always welcomed.

The latest non-manufacturing purchasing manager index for UK was much better than expected. The Markit PMI September index, published on Thursday, stood at 52.6. While the weaker GBP was guaranteed to lift the outlook for the manufacturing sector, it was expected that the service sector would suffer. This clearly has not happened.

The good economic data has washed away expectations of future rate cuts. Earlier this week, the implied probability of a rate cut in the UK in November was 11% (it was 20% at the beginning of September) and the probability of a rate cut in December was 16% (26% in the beginning of September).

The weaker GBP will increase inflation expectations, which will likely lower the rate cut probabilities even more. Perhaps a chance of a rate hike will slowly creep back into discussions as well. That could begin to provide some support for the GBP eventually.

Edited by Robert Ryan

Juhani Huopainen is a blogger and a macro analyst at MoreLiver’s Daily. Follow Juhani or post your comment below to engage with Saxo Bank's social trading platform.

Siru Nurmi Siru Nurmi
Several days GBP has hit records with thinner and thinner order book until there was left only crazy orders. It is also record heavily with sell positions, just added this and last week. So, the obvious just happened. George Soros estimated 20% decreasing in GBP when brexit comes, and 1.2000 is very near it. What will happened next? Search for guilty ones, BoE is very happy, GB industry is happy, order flow, and soon GB is also free from EU regulation.


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