Here's why the British pound fell out of bed in Asia, according to the CBA

Mandatory Credit: Craig Prentis /Allsport

The British pound fell out of bed in Asia on Friday, plummeting 10% in a matter of minutes to a fresh 31-year low against the US dollar.

It’s been the talk of markets ever since, stealing the limelight from what is usually the centre of attention on the first Friday of the month, US non-farm payrolls.

After watching the pound plunge, more akin to a waterfall or a bungee jumper if you take in the subsequent price action, the question everyone is now asking is what exactly happened? And that even includes two experienced traders who work together at Business Insider.

Was it a fat-finger, fears over a hard Brexit from the European Union, a crafty hedge fund, a whirlwind of algos acting in unison or thin market liquidity, amplified by what was expected to be a quiet Friday trading session in Asia ahead of the payrolls report?

Or was it a combination of all of the above?

Richard Grace, chief currency strategist at the Commonwealth Bank, reckons he knows the answer.

Here’s what he wrote in a research note following the pounding of the pound:

It appears the combination of thin liquidity, fund selling, and comments by EU officials, that Brexit must be made tough for the UK to safeguard the “fundamental principles of the EU”, are behind a rapid 10% decline in GBP/USD.

Foreign exchange market liquidity was particularly thin given it was midnight in London, 7pm in New York, and 8am in Tokyo, when the large 10% decline in GDP/USD briefly occurred. Recent global regulatory changes have also been behind a drying up of USD and foreign exchange liquidity, compounding the traditionally thin-liquid period that typically occurs during foreign exchange’s 24 hour trading window.

It is possible some opportunistic hedge funds, model-based accounts including algorithmic traders, seized the chance to capitalise on the thin market liquidity and aggressively sold GBP/USD, triggering a series of stops.

A combination of things, putting it succinctly.

The initial moves was likely sparked by an article that ran in the Financial Times in which French president François Hollande called for a hard Brexit for the UK.

Hollande didn’t hold back in front of EU president Jean-Claude Juncker, stating that “we must go all the way through the UK’s willingness to leave the EU. We have to have this firmness”.

Like a snowball, that kicked off the selling and all of the other factors listed above exacerbated the pound’s decline.

The GBP/USD currently buys 1.2438, down 1.4% on the day but up 5.3% from the session lows.

GBP/USD 1-Minute Chart. Source: Thomson Reuters

NOW READ: This table from HSBC explains the difference between a ‘hard’ and ‘soft’ Brexit

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