Sterling’s instant fall may be down to rogue algorithms but the general decline points to investors’ concern at the direction of British economic policy
By Buttonwood
THE foreign exchange markets are about the most liquid trading arena in the world, certainly for the major currencies. So sterling’s 6% fall in two minutes this morning—from $1.26 to $1.18 (see chart below), with a similar-sized move against the euro—was a very unusual event.
Traders’ minds went back to the Swiss franc’s sudden jump in early 2015, when the currency rose by 30% in an instant. But that was down to a change in policy; the abandonment of the Swiss National Bank’s cap on the franc’s strength. There was no such news to affect the pound.
The best explanation seems to lie in the world of algorithmic trading—the computer programmes that automatically generate transactions. Such programmes have been blamed for “flash crashes” in the equity markets, particularly the May 2010 event which saw the Dow plunge nearly 1000 points in minutes before recovering. The problem seems to be that programmes feed off each other. Each may have a trigger point which requires the programme to sell an asset (currency, bond or share) when it falls below a certain point, in order to limit losses. These sales drive the price down, which triggers the selling points of other programme and so on. Eventually, the fall is large enough that other elements of the algorithm generate a buy signal. Hence the whole event can be over very quickly.
If there was a trigger for the sell-off, it may have been reports of the speech of François Hollande, the French president, on the need for a hard Brexit. As such, Mr Hollande’s comments were hardly a surprise, and he probably won’t be in office for the bulk of the negotiations (although his successors may be just as tough). But one suggestion is that some algorithms use headlines from social media such as Twitter and Facebook to generate trades; a deluge of reports mentioning “hard Brexit” might have been enough to sell. Simon Derrick of BNY Mellon also points out that liquidity is at its thinnest in Asian trading (when the crash occurred); and investors may also have had thin positions ahead of the non-farm payrolls, out later on Friday.
But there is more going on that just a bunch of computer programmes. The pound had a big fall when Britain voted to leave the European Union but settled around the $1.30 level. As the direction of government policy became clear, a new decline has begun. Even before today’s move it had been drifting down to 30-year lows against the dollar and has been trading around its weakest-ever level in trade-weighted terms. Even after a rebound from the flash crash, sterling is still below $1.24 and just above €1.11 against the euro.
The hard-Brexit, anti-immigrant, anti-business tone of the Conservative Party conference has alarmed investors, including as it did the Orwellian proposal to make companies declare the number of their foreign workers. Here is Unicredit on the market mood:
Regardless of the exact reason behind the overnight crash, there emerges an overarching point: it is not just about the UK’s free access to the single market and trade becoming costlier; investors are now perplexed by the country’s vision on immigration, openness and business-friendliness. This will be detrimental to the outlook for sterling given the global status that the UK has enjoyed for so many years. It is still early days to determine the end-result but one thing seems certain: sterling will remain under severe pressure. We reiterate our forecast for GBP-USD at 1.20 and EUR-GBP at 0.93 by year-end.
Of course, as many will point out, a decline in the currency is good for exporters. It is also good for the foreign currency earnings of the multinationals listed in the FTSE 100. But unless a currency is overvalued (as the pound was in 1992), it is folly for a nation to celebrate a sharp decline. If devaluation were the answer to economic success, people in Venezuela and Zimbabwe would be rich. A weaker currency is a decline in the terms of trade; it costs more for citizens to buy foreign imports they want and their exports are lower in price. As a trading nation with a current-account deficit, Britain is dependent on the kindness of strangers; the willingness of foreign investors to send capital. The prime minister may have been cheered by the Conservative party faithful but those cheers will ring hollow if she drives those investors away and causes a sterling crisis. She might even acquire the nickname of another unelected British leader from the 17th century—Tumbledown Theresa.
