The pound had a rollercoaster ride overnight, with GBPUSD falling to 1.1841 before climbing back to 1.2440. The highly sensitive GBP/JPY plunged 1,300 pips, and EUR/GBP spiked to 0.9415. The driver of this massacre: apparently algorithms (over)reacting to comments in the FT from French President Francois Hollande about the UK’s potential hard Brexit.
As we approach the start of the London session, the pound has recouped some losses, but crucially it has not returned to the pre-sell off levels versus any of the major currencies. GBP/USD is at a fresh 31 year low below 1.25, while EUR/GBP is still 200 pips higher at 0.8930; the low on Thursday had been 0.8785.
Algos get trigger-happy on headlines
Apparently it was a rogue algorithm that triggered the sell off after it picked up comments made by the French President Francois Hollande, who said if Theresa May and co. want hard Brexit, they will get hard Brexit. These days some algos trade on the back of news sites, and even what is trending on social media sites such as Twitter, so a deluge of negative Brexit headlines could have led to an algo taking that as a major sell signal for GBP. Once the pound started moving lower then more technical algos could have followed suit, compounding the short, sharp, selling pressure.
Thus, the pound has been the victim of the digital, headline-driven world that we live in today. For sterling, algorithms have become the modern-day version of a George Soros.
Politics: a dangerous game for the pound
The big issue for the pound right now is that it has become detached from the economic fundamentals and politics have become king. This is where things will get dangerous for the currency going forward. Theresa May’s hard-line on Brexit negotiations and her insistence that negotiations will take place in private have only increased uncertainty for the market, with traders left combing news websites for the latest headlines to try and gauge for themselves the state of play between the UK and the EU.
Will Hollande even be in power for Brexit talks?
Another problem with politics being the chief driver of the pound is that it is unstable. There is a huge list of ever changing characters within the EU. Francois Hollande, whose comments on Brexit were thought to have triggered the flash crash in the pound, may not be in power to see the Brexit negotiations if he is ousted by challenger Nicholas Sarkozy in next May’s French Presidential election. Unfortunately for pound bulls, the algos didn’t think to put the Hollande story in any context. If Sarkozy does return to power, he has suggested he would take a more favourable stance with the UK during exit negotiations, so we have no idea at this stage how Brexit will play out.
Another flash-crash could be on the cards for the pound
This highlights the drawback of machines making trading decisions, however, it is the reality, and it is only getting more popular. Thus, another flash crash is possible. Unlike the flash crash that impacted the Dow Jones in 2013 and which triggered an investigation by the US authorities, the FX market is not regulated in the same way, so there is unlikely to be an investigation and we may never know what actually happened last night. But, if there is another flash crash, the pound is vulnerable because such unstable forces are driving it.
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