Witching Hour for Currencies Strikes Again as Yen Breaks Loose

(Bloomberg) -- The currency market’s so-called witching hour struck again on Thursday, to the detriment of traders who were long the Australian dollar and Turkish lira.

The window of trading in the global day between the close in New York and the open in Tokyo has become notorious in recent years as thin liquidity exposes financial markets to rapid swings. Foreign-exchange volumes dwindle to just 2 percent of peak turnover during this period, according to data from consultancy Aite Group issued in 2016.

In January 2016, South Africa’s rand tumbled as much as 9 percent in minutes, while the pound plummeted more than 6 percent in a few frenzied minutes in October that year. Add the yen to the list now.

If liquidity was thin in those past incidents, it was worse on Thursday with Japan shut for the last day of its new-year holiday break. Orders to dump the Australian dollar and the Turkish lira against the yen spread rapidly to other crosses as algorithm trading kicked in. Within minutes, the haven asset was surging against every foreign exchange tracked by Bloomberg.

“A key aspect was the move occurred before midnight GMT before any major market makers were active, a perfect mix for market chaos,” said Fatih Atalay, head of eFX trading at Swissquote Bank SA. “It would be hard not to view the move as a harbinger of volatility in 2019.”

Flash crashes have become more of a hazard for markets as regulatory limits to risk-taking by banks since the global financial crisis spurred them to trim inventories. As a result, when a sudden flood of orders hit screens, market makers are less able to fulfill demand, leading to pricing spikes. To reduce exposure, some investors have taken to cutting positions ahead of holidays.

“It scares the living daylights out of everyone to see this sort of stuff,” said Chris Weston, head of research at Pepperstone Group Ltd. in Melbourne. “Even speculators don’t want to see this type of situation because you might get on the right side of it, fantastic, but you might not.”

Thursday’s volatility isn’t isolated and investors should brace for more swings, said Tuan Huynh, chief investment officer, Asia Pacific, at Deutsche Bank Wealth Management in Singapore.

“We have pointed this out to our clients that more and more of these algo trading are coming up, so you have to be prepared for these kind of trading patterns,” said Huynh. “We saw it last year in the equities space two times, and before that also once or twice a year.”

One-month implied volatility for the dollar against the yen jumped to the highest since February. In the space of seven minutes from 9:30 a.m. Sydney, the Japanese currency gained almost 8 percent against the Aussie, while also surging 10 percent against the lira. Traders reported losses as they struggled to cope with the extent of the move.

More price gyrations may be in store this year during Asia’s witching hour, particularly with uncertainty ranging from the U.S.-China trade war, developments in Brexit, and the global stock rout, analysts said.

“If you’re going to put money on the table, then steep volatility is to be expected for a while,” said Jingyi Pan, market strategist at IG Asia Pte. in Singapore. “If you’re in and ready for big swings, this is likely to continue for a bit -- otherwise this is a time for risk aversion.”

©2019 Bloomberg L.P.