The stock market is the big-man-on-campus of the capital markets. Stocks get all the attention. Stocks get all the hype. Even if the futures market is bigger, even if the forex market is bigger, the adulation always goes to stocks. Nobody makes movies about forex traders; at least, none that anybody remembers. The forex market, though – where more than $5 trillion moves on a daily basis, compared to about $191 billion in the equities market – is where the real capital-market muscle lies, and Wednesday's manic session illustrated that perfectly.
On Wednesday, global markets from London to New York to Tokyo were roiled by a sharp rupture in the forex market. It started with trading in the U.K. pound and New Zealand dollar. Key data in the U.K. lifted the pound, and an upbeat take on the local economy from New Zealand's central bank boosted the kiwi against the greenback. Normally, that might not be such a big deal, but trading in those pairs dinged the heavily oversubscribed "long dollar" trade.
With central banks telegraphing monetary policy, traders the world over have piled into bets that the U.S. dollar will continue to strengthen. European Central Bank President Mario Draghi has been talking about never giving up, the Bank of Japan 's Haruhiko Kuroda has been going into negative territory, and the Fed has been talking about hiking. It's been an easy bet for traders, until something, anything, goes amiss, which is what happened yesterday.
The rapid unwind happened "in a manner unseen since the violence of the few days following the tsunami that hit Japan's coast several years ago and previously seen in the late summer of '97 when the Soviet Union was collapsing and political chaos was the order of the day," Dennis Gartman wrote in his daily Gartman Letter.
The reversal in the pound and kiwi quickly jumped to other trading pairs, most notably the yen and euro, both of which jumped by more than 1% against the dollar. Indeed, "the last couple of days have seen a huge turnaround in 2016′s currency rankings," noted Societe Generale forex strategist Kit Juckes. The Malaysian ringgit's gains, for instance, is now at the top of the rankings against the dollar, and other currencies, like the Hungarian forint and Norwegian krone, that have been sliding, for years in some cases, against the U.S. dollar, suddenly find themselves looking quite strong.
It's all so unexpected, Mr. Juckes said, as to make the forex market look "as mad as a bag of ferrets."
After the forex market came to a boil, it was inevitable that the moves would jump the banks into other assets. The crude-oil market–don't forget oil is priced in U.S. dollars–went ballistic. Nymex crude rose 8% on the day. U.S. stocks fell, turned around and rose, fell again, and then surged into the close.
"The correlation between the dollar's trade-weighted value and the price of oil remains absurdly high," said Mr. Juckes. "Oil and the dollar, together amid the chaos."
Be warned, though, this move can turn against traders as abruptly as it turned in their favor. "We remain sellers into strength in coming weeks/months of risk assets," Michael Hartnett, the chief investment strategist at BofA/Merrill Lynch, "at least until a coordinated and aggressive global policy (e.g. Shanghai Accord) begins to reverse the deterioration in global profit expectations (currency heading sharply south) and credit conditions."
That idea of a "Shanghai Accord" or a "Plaza 2″ – a reference to the 1985 agreement among the U.S., U.K., Germany, France, and Japan to control the appreciation in the dollar – has been an emerging theme lately, Mr. Juckes said. It's not hard to see why that would be appealing; central banks all seeming to run in their own directions without any coordination, and exhausting the bounds of their abilities, is one big reason the market looks like that bag of ferrets. "Central banks are all but out of ammunition, and the risk that China can't control its currency or financial markets without imposing much tougher capital controls is pretty high."
But he was wary about the idea. "Given that Plaza persuaded Japan to embark on ruinous course of fiscal expansion, yen strength and asset bubbles, I'm not sure a repeat's such a good idea, but a more coordinated response to the current crisis would help."
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