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 algorithmic 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.”

Witching Hour for Currencies Strikes Again as Yen Breaks Loose

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.”

Volatility Watch

While analysts said investors should brace for more volatility in currencies this year, they weren’t too worried about the likelihood of another exaggerated move in the yen anytime soon. The return of Japanese investors from the new-year holiday should help liquidity, while policy makers are also likely to step in if the swings are extreme, according to Pepperstone’s Weston.

Japanese authorities last intervened in the market in November 2011, according to historical data. The yen was then at 78.24 per dollar, much stronger than the current level of around 108.

One-month implied volatility for the dollar against the yen jumped to the highest since February on Thursday. 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.

Witching Hour for Currencies Strikes Again as Yen Breaks Loose

The yen may be safe for now but uncertainty in the markets means more price gyrations might be in store this year during Asia’s witching hour, with potential drivers ranging from the U.S.-China trade war, to 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.”

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