The largest oil crash in nearly three decades has compounded market stress caused by the coronavirus epidemic, leaving traders staggering and leading to growing signs of tension and dislocation in the financial markets.
Government bonds went up and stocks went down for more than two weeks, but although prices have moved a lot, market conditions have generally been smooth and orderly.
It started to crack on Monday. After Saudi Arabia’s decision over the weekend to start a total price war sent crude oil crashing, currencies and stocks began to move in unusual ways.
“Today is the first day we can see the markets becoming truly dysfunctional,” said Luca Paolini, chief strategist at Pictet Asset Management. “It really hurts.”
Signs that Monday would be a historic day for the markets became clear in the first light of day in Asia, when the Chicago Mercantile Exchange’s US equity futures fell 5% and reached their authorized trading limits. . The CME, the world’s largest futures exchange, has also increased margins overnight on a range of interest rates, currencies, metals and agriculture.
When the Asian stock markets opened, Japanese stocks quickly slid into a bear market – defined as a 20% drop from their recent high. The Asian currency markets also experienced significant fluctuations which pushed the Japanese yen to its highest level against the dollar since October 2016. More alarming, the Australian dollar lost 3% of its value in just three minutes to reach its lowest level against the dollar since the financial crisis.
The Australian currency had been under pressure in the 20 minutes before the crash, but at 1:49 a.m. in London, the exchange rate fell, falling to almost $ 0.63 in one minute before climbing to around $ 0.645. “It was definitely a flash crash in my opinion,” said Xavier Porterfield, research manager at the data company New Change FX.
This turned out to be a sign of things to come when the European markets started to trade. Dozens of shares on the London Stock Exchange were temporarily suspended when the market opened. On Xetra, the German stock exchange, there were 1,300 “volatility interruptions” – when trading slowed – during the first three hours. This exceeded the total the day after the British referendum on leaving the EU.
Stress continued during the opening of the American stock market, the S&P 500 immediately falling by 7% and triggered a market-wide “circuit breaker” designed to slow down panic selling by forcing a 15-minute stop to negotiation. It was the first time that the measure had been used since its introduction in 2013. But the break offered little respite.
“The markets were already grappling with an unknown and uncontrollable problem with the coronavirus, and now they have been hit by a huge oil shock,” said Peter van Dooijeweert, head of corporate coverage at Man Group. “We are seeing signs of stress everywhere.”
Although the past few weeks have been volatile, it was a new level of turbulence. At the start of the sale in late February, investors and traders stressed that the markets had been orderly.
But liquidity has deteriorated in many important markets. This means that the falls have become more marked and more irregular than normal. Business conditions on Monday were exceptionally difficult.
“It looks like everything is cracking right now,” said a stock broker who declined to be identified. “It’s just fear and panic in the same way that a member of the public goes out and buys toilet paper in bulk.”
The most notable example is found in the US futures market. Its “depth” – measured by the number of contracts listed near the best price – has collapsed by around 90% since mid-February, according to JPMorgan. Traders and fund managers also said that the deterioration in liquidity was apparent in the bond market.
Even the highly rated public debt, normally the most tradable asset class, was not spared, as the spreads between offers and offers widened.
“There have already been some air pockets, but today is the first very big one,” said Mike Riddell, fund manager at Allianz Global Investors.
The US Federal Reserve is taking steps to ensure that market conditions do not deteriorate. On Monday, it announced that it would inject additional liquidity into the short-term credit markets.
The measures come at a time when many trading rooms have been cleared, with several banks and hedge funds allowing employees to work in disaster recovery sites, or from their homes, to minimize the risk of spreading disease. Traders report that offshoring took effect at a difficult time – just as volatility picked up and volumes doubled.
“How risky do you feel comfortable working from home? For trading offices and asset managers, this will only exacerbate the problem of poor liquidity,” said van Dooijeweert. of Man Group.