The End Game has arrived
Shocks from covid and the war in Ukraine have forced the global financial and political world to change, but what will the end game be?
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JPY cross flash crash points to dysfunctional market
John Hardy
Head of FX Strategy
Summary: The Japanese yen ripped higher late yesterday after an Apple profit warning triggered a global risk-off wave that an illiquid holiday market in Japan was unable to absorb, creating the largest flash crash since a sterling flash crash over two years ago. Look for the beginning of a round of intervention on this latest sign of a desperate shortage of market liquidity.
Liquidity conditions in global markets have gone from bad to worse – in October of last year it was the oil market and US equity markets suddenly shifting into a new regime of violent intraday swings as liquidity evaporated. At the time, we noted the remarkable lack of contagion into currencies, particularly EM, where signs of global risk off failed to trigger much more than a distant echo of the past patterns of safe haven seeking.
That all started changing in the final days of 2018 as the slumbering JPY dragon was finally awoken in its lair and then belched white hot fire overnight. The proximate trigger is almost irrelevant – after all, the Apple profit warning news moved the S&P 500 futures some 1 percent or so, hardly remarkable relative to recent trading ranges.
More important was that prior to the news, several JPY crosses had plunged rather quickly to new multi-month lows, setting in motion the snowballing of stop orders and margin calls once a fresh piece of bad news hit the wires – accentuated further by widespread speculative short yen interest and poor liquidity over Japan’s extended market holiday (markets will be open in Japan tomorrow). Whether we have seen the actual lows for now in JPY crosses, volatility in JPY crosses has likely peaked already as a move of this size will trigger inevitable hyper-vigilance from authorities. And eventually, as outlined in our Steen Jakobsen’s piece from last month outlines the risk of a “Policy Panic” has only escalated with a move like this.
Chart: AUDJPY monthly
AUDJPY suffered the worst of the JPY flash crash overnight. The 72.50 area is a critical one for the pair, as it has marked the low of the range since the pair rallied from the depths of the global financial crisis. This flash crash took the pair beyond that level briefly overnight – but this pair is a good measure for whether markets continue to drop on further risk deleveraging or is “saved” for now by hopes for a US-China trade détente or signs that the authorities – mostly importantly the Fed – are sufficiently concerned that global financial markets risk serving as the horse and not the cart of the global economy that they are willing to consider a new shift toward a more profound easing.
We have argued that the further expansion of debt after the global financial crisis requires that any policy response has super-sized the problem to the degree that the coming policy response goes beyond central bank’s mandates. That brings three risks, first that the bar is higher for central banks to respond forcefully as they recognise that previous measures were not effective in engineering anything resembling a sustainable revival in the economy. Second, the starting point for most global central banks is already near the zero bound on interest rates. Finally, if central banks aren’t up to the task, the political leadership is only prompted into acting once a crisis is in full fledge, as we saw with the TARP package in the US and with the EU political leadership’s response to the serial escalations in the EU sovereign debt crisis.
That all started changing in the final days of 2018 as the slumbering JPY dragon was finally awoken in its lair and then belched white hot fire overnight. The proximate trigger is almost irrelevant – after all, the Apple profit warning news moved the S&P 500 futures some 1 percent or so, hardly remarkable relative to recent trading ranges.
More important was that prior to the news, several JPY crosses had plunged rather quickly to new multi-month lows, setting in motion the snowballing of stop orders and margin calls once a fresh piece of bad news hit the wires – accentuated further by widespread speculative short yen interest and poor liquidity over Japan’s extended market holiday (markets will be open in Japan tomorrow). Whether we have seen the actual lows for now in JPY crosses, volatility in JPY crosses has likely peaked already as a move of this size will trigger inevitable hyper-vigilance from authorities. And eventually, as outlined in our Steen Jakobsen’s piece from last month outlines the risk of a “Policy Panic” has only escalated with a move like this.
Chart: AUDJPY monthly
AUDJPY suffered the worst of the JPY flash crash overnight. The 72.50 area is a critical one for the pair, as it has marked the low of the range since the pair rallied from the depths of the global financial crisis. This flash crash took the pair beyond that level briefly overnight – but this pair is a good measure for whether markets continue to drop on further risk deleveraging or is “saved” for now by hopes for a US-China trade détente or signs that the authorities – mostly importantly the Fed – are sufficiently concerned that global financial markets risk serving as the horse and not the cart of the global economy that they are willing to consider a new shift toward a more profound easing.
We have argued that the further expansion of debt after the global financial crisis requires that any policy response has super-sized the problem to the degree that the coming policy response goes beyond central bank’s mandates. That brings three risks, first that the bar is higher for central banks to respond forcefully as they recognise that previous measures were not effective in engineering anything resembling a sustainable revival in the economy. Second, the starting point for most global central banks is already near the zero bound on interest rates. Finally, if central banks aren’t up to the task, the political leadership is only prompted into acting once a crisis is in full fledge, as we saw with the TARP package in the US and with the EU political leadership’s response to the serial escalations in the EU sovereign debt crisis.
In the US, the path towards a significant government response to any budding crisis has been significantly impeded by the 2018 mid-term election. The new Congress meets today for the first time and the spectacle of a Trump, and a Democratic House bent on taking down the president, risks a dysfunctional response when and if the US economy hits the skids.
The G-10 rundown
USD – this latest volatility event risks setting markets further on edge and the risks tilt increasingly towards the Fed eventually being forced into a change of tune. But a significant turn in the USD to the downside may not come until the Fed is well into an easing cycle – if we are to take the 2000-2003 and 2007-2009 periods as lessons for how the USD responds to Fed easing.
EUR – EURUSD looked bearish yesterday on the close, with USDJPY flows distorting the action in USD pairs overnight. Need a close below the 1.1250-15 area to get something started there. Note that authorities have suspended trading of the shares of Italy’s tenth largest bank Carige as the bank has been put in administration by the ECB.
JPY – the yen’s immunity to risk off only began fading notably in the tail end of the year and its safe haven status has suddenly roared to live. There could be more in the move, but given that USD liquidity and not JPY liquidity is the chief source of the world’s financial market pair, I would be surprised if this move continues with anything approaching the same vehemence as this may have mostly been a liquidity and leveraged positioning-driven move.
GBP – EURGBP pulling well above 0.9000, but shying away from new JPY-flash-crash inspired highs. Sterling weakness perhaps in part down to opposition leader Jeremy Corbyn expressing reluctance to support a second referendum.
CHF - EURCHF back from beyond the 1.1200 brink as the pair seems to merely serve as a weak echo of risk-on, risk-off developments. A more profound move lower likely would require a sense that new significant immediate EU existential risks are afloat. Brexit is the most critical of these at the moment, but is not new.
AUD – the AUDUSD chart blown apart by the overnight flash crash – for now, just have to concentrate on the fact that 0.7000 has given way and we continue to fret AUD on exposure risks to China and a domestic credit crunch linked to housing.
CAD – the loonie is largely sitting out the volatility. AUDCAD still an interesting one for downside potential despite the misleading daily candlestick created by yesterday’s JPY flash crash.
NZD – flash crash overnight fed into AUDNZD – this is liquidity stress in AUD from all appearances due likely to AUDJPY flows. This creates a misleading bar on the chart.
SEK – market volatility is no friend of the krona’s. Frustrated bears will want this latest rally erased quickly or we risk limbo back in the higher range again. On the one hand, Riksbank expectations and Swedish rates are holding up well, but on the other hand, Sweden has its own issue with housing and today’s household lending data release shows the lowest year-on-year growth (at 5.7%) since 2014 as Sweden’s GDP posted a negative QoQ GDP reading in Q3. Back in 2012, a drop below 5% YoY in lending coincided with a brief Swedish recession as the Riksbank tried to normalise interest rates.
NOK – the reversal back lower in EURNOK needs to pick up pace again, otherwise the pair showing signs of comfort above the key 9.75-9.80 area and risking higher levels still if oil prices haven’t posted their cycle lows here.
Upcoming Economic Calendar Highlights (all times GMT)
0930 – UK Dec. Construction PMI
1315 – US Dec. ADP Employment Change
1330 – US Weekly Initial Jobless Claims
1500 – US Dec. ISM Manufacturing
The G-10 rundown
USD – this latest volatility event risks setting markets further on edge and the risks tilt increasingly towards the Fed eventually being forced into a change of tune. But a significant turn in the USD to the downside may not come until the Fed is well into an easing cycle – if we are to take the 2000-2003 and 2007-2009 periods as lessons for how the USD responds to Fed easing.
EUR – EURUSD looked bearish yesterday on the close, with USDJPY flows distorting the action in USD pairs overnight. Need a close below the 1.1250-15 area to get something started there. Note that authorities have suspended trading of the shares of Italy’s tenth largest bank Carige as the bank has been put in administration by the ECB.
JPY – the yen’s immunity to risk off only began fading notably in the tail end of the year and its safe haven status has suddenly roared to live. There could be more in the move, but given that USD liquidity and not JPY liquidity is the chief source of the world’s financial market pair, I would be surprised if this move continues with anything approaching the same vehemence as this may have mostly been a liquidity and leveraged positioning-driven move.
GBP – EURGBP pulling well above 0.9000, but shying away from new JPY-flash-crash inspired highs. Sterling weakness perhaps in part down to opposition leader Jeremy Corbyn expressing reluctance to support a second referendum.
CHF - EURCHF back from beyond the 1.1200 brink as the pair seems to merely serve as a weak echo of risk-on, risk-off developments. A more profound move lower likely would require a sense that new significant immediate EU existential risks are afloat. Brexit is the most critical of these at the moment, but is not new.
AUD – the AUDUSD chart blown apart by the overnight flash crash – for now, just have to concentrate on the fact that 0.7000 has given way and we continue to fret AUD on exposure risks to China and a domestic credit crunch linked to housing.
CAD – the loonie is largely sitting out the volatility. AUDCAD still an interesting one for downside potential despite the misleading daily candlestick created by yesterday’s JPY flash crash.
NZD – flash crash overnight fed into AUDNZD – this is liquidity stress in AUD from all appearances due likely to AUDJPY flows. This creates a misleading bar on the chart.
SEK – market volatility is no friend of the krona’s. Frustrated bears will want this latest rally erased quickly or we risk limbo back in the higher range again. On the one hand, Riksbank expectations and Swedish rates are holding up well, but on the other hand, Sweden has its own issue with housing and today’s household lending data release shows the lowest year-on-year growth (at 5.7%) since 2014 as Sweden’s GDP posted a negative QoQ GDP reading in Q3. Back in 2012, a drop below 5% YoY in lending coincided with a brief Swedish recession as the Riksbank tried to normalise interest rates.
NOK – the reversal back lower in EURNOK needs to pick up pace again, otherwise the pair showing signs of comfort above the key 9.75-9.80 area and risking higher levels still if oil prices haven’t posted their cycle lows here.
Upcoming Economic Calendar Highlights (all times GMT)
0930 – UK Dec. Construction PMI
1315 – US Dec. ADP Employment Change
1330 – US Weekly Initial Jobless Claims
1500 – US Dec. ISM Manufacturing