Late on Wednesday, in that illiquid period between 5pm and 6pm, when most investors are either sleeping or otherwise away from their computers, the FX market was hit with a series of flash crashes, which mostly hit various Yen-linked pairs – especially the Turkish lira – but also affected several other FX carry trades including Cable and the Aussie Dollar.
So having been hit by this stark reminder just how dangerous it can be to “pick up pennies in front of a steam roller” as Nomura put it, did traders – and especially Mrs Watanabe who was among the main alleged culprits for the post-AAPL guidance cut fiasco – learn their lesson?
The answer appears to be no, because as Bloomberg’s Ye Xie notes, one explanation for today’s perplexing dollar weakness – which comes at a time of a near-record surge in 10Y yields– is that “investors are buying high-yielding EM currencies with both hands” as seen by Bloomberg’s EM Carry Index which has reached the strongest since July.
Three reasons were cited for this powerful fund reallocation: the first is today’s unexpectedly strong jobs report, which saw the most job additions in 10 months, indicates that contrary to Thursday’s post-ISM fears, “recession risk remains low as the economy absorbed more workers who re-joined the labor force” and, as Xie notes, “as the world’s largest consumer, a healthy U.S. economy is a necessary (even if not entirely sufficient) condition for EM to rally.”
The second reason, of course, was Powell’s latest dovish relent, when in a speech alongside Yellen and Bernanke, Powell pledged patience and assured markets that he is “listening carefully” while backing away from the “Fed’s balance sheet is on autopilot” statement. As such, Powell “not being hawkish” was sufficient for EM to rally.
Finally, today’s higher commodity prices and China’s RRR cut, and the market had a “perfect recipe” for the carry trades such as ZAR, CLP and, of course, the TRY which plummeted less than 48 hours, to rally as many of the positioned that were wiped out just two days ago are reloaded.
In conclusion Xie notes that “how long this can last is anyone’s guess” but adds that some stability in the S&P 500 and a few positive China data points would go a long way to boost sentiment on EM.” That, or another carry-driven flash crash following the next major downside surprise…
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