(For our readers who weren’t trading FX in 2008, when Lehman Brothers and Bear Stearns went bust after the US property market bubble exploded in everyone’s face).
The FX market had been building the risk-on trade for many years as equity markets roared higher and the ‘carry’ on trades like AUD/JPY was excellent. This pair got to 110 and looked like it would never fall ever again. Once the banks blew up, everyone tried to bail out of these trades at the same time and I remember one particular morning when AUD/JPY fell from 83ish to 73ish in about 3 hours; a fall of 15%.
Over a period of a few months, AUD/JPY fell below 60 and other pairs like EUR/GBP also experienced huge moves. The market wanted to buy USD in the first instance but also JPY, CHF and EUR to some extent. AUD, CAD, NZD and GBP were out of favour. The reasoning behind the USD rally was purely a liquidity issue and the reason behind the GBP fall was due to its exposure to financial markets.
Can history repeat itself? Probably yes but the situation is somewhat different this time around. The big problem now is Sovereign debt, not bank debt. The EUR is in a much different situation and nobody can buy with any conviction; the CHF and JPY are at much higher levels than they were back in 2008 and the market is surely already long both of these currencies; the AUD rise this time has been fuelled more by commodity demand out of China rather than the carry trade so I don’t think it can collapse in the same panic again; the GBP does look vulnerable due to the City of London exposure to European banks; one thing which does look the same is the desire to maintain USD liquidity, as we’ve seen in USD/Asia over the last few weeks.
Conclusion: I don’t think we will see collapses in pairs like AUD/JPY and AUD/CHF like happened last time. The market is structurally different this time around. I personally am sitting on the sidelines, waiting for some clarity; the intraday vol traders will be having a great time.
