FX Price-Less market: What happened in GBP this morning and why these unwanted liquidity events will continue
I know all of us old interbank market dinosaurs will be driving you crazy with our “I told you so’s”, but we did! Whether for regulatory, commercial or technical reasons, the very core of the FX market no longer exists; namely the hundreds of interbank traders who sat at their desks and provided pricing no matter what the conditions. Yes the prices may have been wide and in small amounts at times, but there was always a price in the market. This morning we had another example of a Price-Less market!
Most of the market’s liquidity is handled through a small-ish number of interbank trading platforms with prices being derived via prime brokerage agreements with hedge funds, asset managers, corporates, and retail brokers etc. All of these big interbank trading platforms have algorithms which track liquidity and constantly analyse risk. I suspect that these algorithms are basically written with the same underlying rules. In other words, when one platform panics, they all panic.
What we think happened this morning is that there was a large knock-out option at 1.2600 and once this level broke, a number of automated stop-loss sellers entered the market. As it was early Asian trade, there was very little immediate buying interest to soak up this supply, so the ‘clever’ machines simply matched the supply to wherever the demand was positioned on their platforms. Not many participants place their bids at levels >200-250 pips away; most prefer just to wait until the market starts trading there and then decide what to do. This means that there was a massive black hole with no prices for a rational market participant to make decisions off.
To add insult to injury, another massive 1.2000 knock-out simply compounded the problem and basically the sellers below 1.26 were joined by the sub-1.20 sellers in a matter of seconds. More panic!
Based on the price action since this morning’s events, I would safely guess that if this had happened 15 years ago, we would have seen a nasty sell-off from 1.26 to possibly 1.2400/1.2350 in increments of 25/40 pips before the demand took over and stabilised prices back around 1.2400-50.
Instead of this we will have retail B-book brokers glorying in their ‘record’ profit days. So what exactly is the regulator’s main duty?