Summary
- Cable reached the lowest recorded level of $1.03 (~4.5%) in the early hours of Monday's Asian trade after an aggressive flash crash occurred due to thin liquidity, generally caused by a domino effect from electronic trading systems executing rapid sell trades.
- CME Group had to halt GBP futures trading due to the flash crash.
- Two primary factors for this unexpected move are a combination of a skyrocketing US dollar (from last week's 75bps rate rise) and the UK's mini-budget announcement, which included several tax cuts that seemed to weigh heavily on the GBP.
What happened & why?
The pound fell to all-time lows against the US dollar in the early hours of trade during the Asian session on thin liquidity, which created a flash crash as investors weren't receptive to the UK's planned tax cuts from their mini-budget. The last time cable was this low was in 1985.
The British pound was already facing negative sentiment from traders/investors on Friday after the UK's new chancellor Kwasi Kwarteng announced his new mini-budget that could widen the fiscal deficit. This news, in addition to a surging US dollar which drove the dollar index (DXY) to 114.5, was the catalyst for the major flash crash.
CME Group had to halt GBP futures due to extreme market volatility.
But what is a flash crash?
Flash crashes are abnormal movements in the market where there is heavy selling of securities by high-frequency trading firms/systems. Computer algorithms automatically react to certain conditions and begin selling significant volumes of securities at a rapid pace to mitigate risk & trading losses.
Major exchanges have backup systems called circuit breakers which halt trading to avoid further losses and switch off once the price gains stability and trading can resume normally. This is what we saw with the CME group.
You may recall the last time this happened with cable was in 2020, and more famously, BREXIT.
Impact on traders/investors?
Generally, in these situations, traders/investors tend to avoid trading or opening positions as:
- Extreme volatility in the market results in very wide spreads, which can affect the entry price of your position, therefore higher risk for lesser reward.
- Managing risk becomes more complex as price movements are extreme & random.
- If you did have an open position, you would've seen your account fluctuate significantly, or your broker may have intervened to mitigate the risk caused by this event.
What does the chart tell us?
- Clear downward trend where the price is currently sitting at 1.05.
- At a key support zone (1.07), where price has not been since 1985. We will need to monitor how price reacts in this zone. A break below this level could result in a free fall, waiting for the next support level to be created.
- The resistance zone is back at 1.20,
- With the USD gaining strong momentum and a weaker UK economy over the coming 12 months, we can expect GBPUSD weakness to continue, potentially cracking through this support zone of 1.07 and creating further all-time lows as the currency pair may head towards parity.
What to expect in the future?
The US dollar is expected to continue its run for greater strength primarily due to higher interest rate differentials between the two economies. This, in addition to the macroeconomic backdrop for England, especially around its current recessionary theme, slow growth & high inflation rate, will further widen the gap, causing significant and continued weakness in the currency pair.
There are calls for the Bank of England (BOE) to intervene with a potential intra-meeting move to minimise the risk and gap between the two currencies, providing a very hawkish stance to combat both rapid inflation, interest rates and the currency gap. This will hopefully bring some form of confidence to the economy.
We already saw EURUSD fall below parity, so could we see cable do the same by the end of this year? Make sure you watch this space, folks!
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