While a forced rush for the exit on short yen positions can begin a move, it is the behavior of algorithmic trading entities, who might operate “kill switches” during periods of extreme volatility, which can greatly amplify swings, according to Ray Attrill, head of foreign-exchange strategy at National Australia Bank in Sydney.
Such funds can either move to the sidelines, or switch to trading in the direction of the initial move, he said.
The flash-crash early on January 3, the last day of an extended Japanese holiday, saw the yen surge nearly 4% against the dollar in a span of minutes, the largest swing in the pair since the 2016 US presidential election. A flood of orders to sell Australia’s dollar and Turkey’s lira against the yen triggered the move, with the former falling as much as 7% and the latter 9% against their Japanese counterpart.
The vulnerability of Japanese retail accounts has come into renewed focus in the past year as emerging markets suffered from a dollar-inspired rout. The Bank of Japan’s (BoJ) negative interest rate policy coupled with its tight control over 10-year bonds has deprived savers of interest income and driven the country’s investors towards higher-yielding currencies.
Alongside the Turkish lira, other high yielders when Japanese retail investors hold long positions include the South African rand and Mexican peso, while they are also invested in the Australian and New Zealand dollars, according to open interest data from the Tokyo Financial Exchange.
Thanks to Japan’s “Happy Monday” policy, that moved some national holidays to the first working day of the week to stimulate tourism in 2000, there are nine more extended holidays in 2019, taking into account weekends. Traders nervous about the elevated risk of a flash-crash don’t have too long to prepare — there is a holiday on January 13.
Still, for fund managers such as Kate Samranvedhya, deputy chief investment officer at Jamieson Coote Bonds, such “liquidity gaps” are part of life. “The good thing is that market levels normalised within a few days,” she said of the latest crash. “What market needs to prepare for is higher volatility in normal liquidity conditions in 2019.”