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SA’s flash crash exposes cracks in currency liquidity

The rand plummeted more than 9% on Monday
It took 15 minutes at the start of trading Monday for South Africa’s rand to plummet more than 9 percent in what traders said may be a prelude of the new normal in the global $5.3 trillion-a-day currency market.
Such flash crashes, which have already haunted traders in U.S. stocks and bonds in recent years, will probably become a more regular feature of currency trading as liquidity sometimes dries up amid regulatory limits to financial risk-taking and reduced investor appetite for assets of fragile emerging economies, according to Insight Investment Management Ltd. and Citigroup Inc. South Africa’s rand plummeted by more than 9 percent at one point on Monday morning in Asia against both the U.S. dollar and the Japanese yen, hitting record lows. The rand quickly recovered the bulk of its losses almost as quickly as it fell.

“The rand isn’t alone in this,” said Paul Lambert, head of currencies at Insight, a Bank of New York Mellon Corp. unit, in London, which manages more than $582 billion in assets. “The rand is another reflection of the change in the liquidity environment in which we’re all operating. We’re learning that unless there are clients on the other side, banks are very unwilling to take risk onto their books.”

Volatility in the rand versus the dollar surged to the highest level in four years, while a measure of global currency price swings followed suit, climbing to the highest since October. The gap between prices at which traders were willing to buy and sell the rand, used as a gauge of liquidity, was more than 1.5 times wider on average in the past six months than it was over the first half of 2015.

As regulation pushes banks to reduce their size and cut down on market making activities, the ability to trade without having prices move against you is becoming more difficult. A reduction in liquidity has contributed to similar price swings in fixed-income securities in recent years, including the $13 trillion U.S. government bond market.

Unusual bursts of volatility in currency markets and meager liquidity are another affliction for troubled emerging economies such as South Africa, which seek to secure overseas investments amid slowing growth, a rout in commodity prices and domestic political challenges. Securing international trade and capital inflows is made harder by the currency turmoil as investors and banks become less willing to take on additional risk.

“You need to have a portfolio that is as diversified as you can make it, with not too much risk in any one position,” Lambert said.

Early trading

The lack of investors trading the rand in early Asian market hours on Monday combined with reduced interest in South African assets amid uncertainty about the country’s financial and fiscal policies may have contributed to the rand’s abrupt price swings.

“That is why emerging market currencies need to be risk managed differently,” said Richard Benson, a money manager at currency hedge fund Millennium Global Investments Ltd. in London. “I avoid having positions in the highly illiquid currencies.”

The currency deepened its decline as Japanese retail investors unwound their bets that the rand will gain versus the yen, which was a popular strategy known as carry trade, said Gareth Berry, a strategist at Macquarie in Singapore.

“Similar to the rand, a lot of long positions are built up by Japan’s individual investors in the Turkish Lira, which could be next victim of unwinding amid concerns over political instability in Middle East,” said Masakazu Satou, currency adviser at Gaitame Online Co., retail foreign-exchange brokerage in Tokyo. The Brazilian real is also among other higher-yielding currencies with similar long positions, he said.

The rand extended declines on Tuesday, falling 0.5 percent to 16.8608 per dollar as of 11:48 a.m. in Tokyo.

Ministerial appointments

South Africa’s central bank doesn’t target a level for the rand and has said that it won’t intervene to support the currency. The latest selloff in the rand surpasses a slump that pushed it to record low in December after President Jacob Zuma shocked investors by abruptly firing his finance minister, Nhlanhla Nene, and replacing him with a little-known lawmaker. Four days later he rescinded, reappointing Pravin Gordhan, who had held the post between 2009 and 2014.

‘Very difficult’

“It’s going to be very difficult to stabilize dollar-rand at current levels,” said Luis Costa, the head of fixed income and currency strategy for central and eastern Europe, the Middle East and Africa at Citigroup Inc. in London. “This is the medium-term story. The economy hasn’t found yet new equilibrium level. South Africa struggles with important structural issues. That puts the rand on a huge backfoot.”

Spikes in currency trading have befallen markets over the past year. A year ago, the Swiss franc surged almost 30 percent after the central bank abandoned its currency floor against the euro. Banks including Deutsche Bank AG and Barclays Plc lost hundreds of millions amid the volatility and some retail brokers were forced to shut down amid client losses.

More recently, New Zealand’s dollar fell 3 U.S. cents over 10 minutes in late August, before rebounding. The kiwi’s average daily range since 2000 is less than a cent.

“This is enormous volatility and as a real-money investor, you really have to keep your feet out of these kind of markets because that’s just too much volatility with no obvious reason,” said Christoph Kind, head of asset allocation at Frankfurt Trust, which manages about $20 billion. “It’s really tough. I completely cut down my rand positions and I have no exposure there anymore.”

©2016 Bloomberg News



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