Markets

Lisa Abramowicz is a Bloomberg Gadfly columnist covering the debt markets. She has written about debt markets for Bloomberg News since 2010.

The world’s biggest financial market may be destined for a flash-crash future.

This sounds scary because the foreign-exchange market is crucial, determining the real-time worth of every nation’s currency. But violent moves there may not matter as much as they do in other markets, such as those for equities.

Rachel Evans of Bloomberg News wrote an article on Thursday highlighting how the $5 trillion-a-day currency market is undergoing a significant transformation. Trading has been slowing, perhaps because of a lack of investor conviction in the face of central bank intervention. Meanwhile, a growing dominance of algorithmic activity is exacerbating sudden moves.

The article was published within hours of the Bank of Japan’s surprise announcement that it would not add to its record stimulus effort, which sent the yen surging the most against the dollar since 2010. (Many economists were expecting additional easing measures from Japanese policy makers, even though their existing efforts are proving largely ineffective.) The surge comes days after the yen weakened the most against the dollar since 2014.

Air Pockets
The yen has strengthened against the dollar since January, but it hasn't been smooth sailing
Source: Bloomberg

All this is leading to some angst over the fate of currencies and what will happen as this market becomes more prone to hiccups.

Bumping Along
The dollar has weakened this year against major peers, but daily moves are harder to predict
Source: Bloomberg

While flash crashes in stocks can ultimately result in big losses for individual mutual-fund investors, it’s harder to see how sudden, brief disruptive moves in currencies can have a longer-lasting, deleterious effect. Most traders involved in this market are institutional and are less likely to suffer long-term losses because of of a short-term disruption.

First, these markets tend to self-correct very quickly as long as moves aren't spurred by significant news events, which can leave a more lasting effect. Second, the money involved in currencies comes in large part from corporations and other institutions that use foreign exchange as part of their businesses rather than speculators. They tend to sit out of fast-moving markets, waiting for them to stabilize before filling their orders.

The bigger issue is general mistrust of algorithmic trading. Such activity lacks human rationality and is more prone to respond to overblown risks or to amplify sudden shifts in markets. There's a sense that computers can go haywire, roiling financial systems simply because they experience a technological glitch.

Perhaps there are ways to mitigate such potential risk with circuit breakers in currencies, similar to the ones in some equity markets. But computers aren't going away. 

The more likely outcome from the shift in currency market structure is that traders will most likely need to change their habits. For example, rather than leaving a big order hanging out in the market for a prolonged period, traders will perhaps opt to spread out orders or have a shorter time limit on their bids and offers. That way they're less prone to being washed up in a market surge. Or if they're uncertain of whether a market reaction is overblown or not, they'll withdraw from activity and wait for more clarity instead of forging ahead.

So while flash crashes can conjure up images of financial panic or a system gone awry, when it comes to the currency market, it's hard to see how they inflict much long-term damage on overall stability.

This column does not necessarily reflect the opinion of Bloomberg LP and its owners.

To contact the author of this story:
Lisa Abramowicz in New York at labramowicz@bloomberg.net

To contact the editor responsible for this story:
Daniel Niemi at dniemi1@bloomberg.net