The Last Look…
Posted by Colin Lambert. Last updated: September 27, 2022
These are certainly different times in the FX market compared to what we have all become used to, and for a certain generation (mine) there is a certain poignancy in a market featuring central bank intervention and new historic lows – it’s a throwback to our youth!
I was trading Cable the last time it was at these levels in 1985 (yes, that old) and it is interesting to see how things have – and haven’t – changed in the market. One thing that is clearer now than back in 1985 is the actual low. Talk to people and you would get a lot of different levels, personally I have 1.0380 as the 1985 low, but I have heard from people who traded at 1.02 apparently (in very early Australia/New Zealand), and others that believed it was 1.0350.
One thing I can tell you it was not, is what was reported by several media outlets – clearly based upon indicative data rather than actual trades, another benefit of the modern market structure. In 1985 I sold at 1.0390, someone else then sold at 80 – a friend of mine put his hand up for that recently – and then it was suddenly 1.08. Thanks to various legal documentation we can (most of the time anyway!) now establish the low much easier – in this case 1.0327.
Cable bounced in 1985 because the six-month outright price meant that UK companies could hedge dollar exposures at parity, which seemed as good a place as any. Monday’s sharp drop in Asia was also reversed fairly quickly – as we report elsewhere, there are thoughts that this was a flash crash – so the price action was similar, but the drivers different. 1985 was definitely about corporate hedging on a massive scale, this week is more a reflection of the nature of the modern market where sharp moves mean revert, mainly because the initial sell-off was probably exacerbated by a lack of liquidity.
That said, talking to people in the market, the price action in Asia on Monday morning was a little wild, but again, there were price points at which to trade all the way down – and back. This is a little different to 1985 when the market was characterised by big gaps – my recollection is 1.0380 given; 1.04-05 and taken, 1.07-08 and taken again in a matter of seconds. This highlights to me how the FX market has been improved by technology and the advent of more automated market makers.
The commentary around the moves is also insightful. In 1985 the story was uniquely one of dollar strength – other currencies were suffering to the same degree, witness USD/JPY at 260 around that time and USD/DEM at 3.46 (that’s about 0.5650 EUR/USD kids), and there was a lot of talk of some sort of G5 (as it was) accord, which, of course, happened a few months later. Today, and this is pleasing to this old trader, far from FX markets being dominated by machines passing round a hot potato whilst trying to chip a few basis points out, these moves are a reflection of what is happening in the real world. The UK is taking an economic gamble and historically, markets haven’t liked that – as Turkey has recently found out to the lira’s misfortune.
The market is handling these conditions really well, but it could well be that what we are seeing now, is the end of the beginning, rather than the end itself.
On the subject of commentary, the Raidne analysis is insightful, especially how it reflects moves in the AUD a few years back. And while I don’t necessarily agree with the suggestion that this was a flash event – there didn’t seem to be a serious gap when the market almost failed to function – it highlights how FX markets are taking on a pattern of their own when things get really volatile, much as the markets of 1985 had their own characteristics.
The other big event in markets at the moment is the Bank of Japan intervening in USD/JPY. I will gloss over my legendary timing – it was only last week I wondered aloud whether the changed market structure would make central bank intervention more effective – and instead refer to my commentary in the Any Other Business… section of our weekly newsletter. Sadly for the BoJ, seemed to have been proven right (for once I hear you cry). The initial intervention saw the pair fall from 145 to 140 and change, at the time of writing just three business days later? 144.50.
The lesson the Japanese seemingly have to learn, and that the British seem to accept, is that you can’t buck fundamentals. Japan is locked into zero interest rates for the foreseeable future if you listen to the Bank of Japan; the US very much isn’t. Welcome back to the carry trade! Japan can try all it like, but it will take a lot more than its $1.2 trillion in reserves to make up for what is a 5% interest rate differential in the two years.
One more point on what is going on. There is an inevitable short-termism in how people look at markets, but a step back may be instructive. There are plenty of noises about how the dollar “cannot keep appreciating”, but history tells us differently. We had a sustained dollar rally from mid-2014 to 2015, the Dollar Index rose some 18 points – the current rally, over much the same time frame, is 23 points from the low last year.
Here is some perspective, however, with the Dollar Index just shy of 114 at time of writing. In the dollar bull run around the turn of the century, it hit 120, but if we are harking back to 1985, it hit the small matter of 160, having almost doubled in value in three and a half years.
The market is handling these conditions really well, but it could well be that what we are seeing now, is the end of the beginning, rather than the end itself. Inevitably, and again this reflects 1985, with a G20 meeting on the horizon, talk of concerted intervention will inevitably increase (in keeping with my willingness to put myself out there, it won’t happen because the US doesn’t want a weaker dollar at the moment), so conditions could get even more fraught.
The striking thing for me, as someone who has been around for both episodes, is how for all the changes in market structure, behaviour is pretty much unchanged. This just proves to me how markets are reflecting fundamentals, which is their job, as it always has been. They did in 1985, they are in 2022 – it’s just the arena in which those views are reflected is different.
One more point should be made about this. Regular readers will hopefully know that I am not one of those who believe things were “better in the old days” – it was a lot of fun trading back then, don’t get me wrong, but things are just better now for everyone. Assuming the market handles what I believe will be sustained, possibly increased, volatility from here as well as it has to date, I would suggest that the FX industry gives itself a pat on the back.
A prolonged period of sustained volatility was always been seen as a test for the modern-day FX market structure and, thus far at least, it is passing with flying colours.