Updated Oct. 7, 2016 6:18 a.m. ET
HONG KONG—The British pound tumbled dramatically in chaotic trading that included a flash drop in early Asian hours and sustained falls in London. Late morning in Britain, it was down 3% against the U.S. dollar.
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The sharp drop in Asia came amid worries about the U.K.’s exit from the European Union that were accelerated by computerized trades, market watchers said. The pound fell more than 6% just after 7 a.m. Hong Kong time on Friday to as low as $1.1819 from just above $1.26, before recovering above $1.24, according to Thomson Reuters data. But it took another dive in London hours and was down well below $1.23.
“I initially doubted what I saw on my screen,” said Kenji Yoshii, a foreign exchange strategist at Mizuho Securities.
Traders and strategists cited several reasons for what they believed caused the crash. Among them were comments by French President François Hollande in Paris, calling for tough exit negotiations. These remarks, though, were several hours before the crash. They came amid a stream of comments from senior European lawmakers that suggested EU leaders would make it hard for the U.K. to continue having access to the internal free market. The pound’s fall came early in the Asian session, where light trading volumes likely exacerbated the move. As the pound’s descent worsened, it broke technical levels that probably triggered automatic sell orders or selling from trading strategies based on algorithms, traders said.
The wave of selling Friday follows a rough patch for the currency, which has now slumped more than 16% since the U.K. voted to leave the European Union on June 23. Earlier this week, British Prime Minister Theresa May set a date to begin the U.K.’s divorce process from the EU and suggested controlling immigration was more important than maintaining full access to the U.K’s largest trading partner.
While some said the pound’s plunge Friday could have been due to a trading error, others didn’t rule out the possibility it was caused by someone acting deliberately. Opportunistic investors such as hedge funds could have aimed to capitalize on thin trading to sell the pound aggressively, Sydney-based analysts at Commonwealth Bank of Australia said in a note.
“A sudden move in a very quiet time not linked to any information is highly unlikely to be due to any algorithm,” said Lyle Pakula, chief investment officer of Melbourne-based hedge fund AE Capital, which uses automated computer programs to make trading decisions. “In my opinion, the source of the run is likely due to a discretionary trader trying to push the market.”
The pound’s big drop is the latest in a number of unexpected plunges in different financial markets around the world in recent years. For example, the Dow Jones Industrial Average tumbled more than 1,000 points in the first few minutes of trading on August 24, 2015, in part as early losses triggered so-called stop-loss orders.
Last month, economists at the Bank for International Settlements said the increased use of electronic trading platforms and proliferation of trading algorithms have likely played a large role in recent moments of stress in the fixed-income market, such as a sudden, sharp selloff in German bunds last year.
The pound’s sharp drop Friday took market participants by surprise, as it occurred in the “twilight zone” of trading, said Chris Weston, the Melbourne-based chief market strategist at IG, a broker. “This is the sort of time when the big U.S. traders are going home and Asian traders are getting back to the desk,” he added.
Sean Callow, a senior currency strategist at Westpac Banking Corp. in Sydney, sensed something was wrong when he returned to the bank’s trading room after recording his weekly video message to clients. His colleagues looked at him with “both disbelief and concern, muttering ‘6%!’” he said.
“It is typically a quiet time of day,” Mr. Callow said. “I mean, this is a price move you would expect from an emerging-market currency, not from [one of] the most-heavily traded pairs in the world.”
While leveraged funds, a group that includes some hedge funds, have broadly added to negative bets on sterling since July, according to the latest data from the U.S. Commodity Futures Trading Commission, the magnitude of Friday’s slide suggests many investors were caught off-guard.
“There was a complete lack of two-way interest in buying the pound on the way down,” said Jeffrey Halley, a senior market strategist at Oanda.
Still, investors who have recently turned negative on the pound could have gained from the currency’s tumble Friday.
Kisoo Park, a portfolio manager at Manulife Asset Management in Hong Kong, said he started betting against the pound on Monday after Mrs. May discussed the timing and terms of the U.K.’s exit from the EU. “For me, that was a game changer,” he said.
The British pound is the fourth most heavily-traded currency in global currency markets, according to the BIS—although its average daily turnover is less than one-fifth of the U.S. dollar’s average.
Volatility in major trading pairs such as the pound-dollar can be exaggerated by automatic buy or sell orders which are triggered when an exchange rate crosses a certain threshold—usually a round number such as 1.20 for the pound against the U.S. dollar. Certain strategies related to currency options can have the same effect.
Moreover, an array of sophisticated computerized trades can spark automatic trading under some market conditions, such as if volatility spikes or a currency appears oversold. These can intensify the momentum driving market movements.
Earlier in the week, Bank of England Deputy Governor Ben Broadbent said that the BOE could reverse some of its accommodative monetary policy in response to a disorderly fall in the pound, speaking at a WSJ Pro event in London.
A BOE spokesman said Friday it was the bank’s policy not to comment on foreign exchange market intervention, when asked whether it had been active in currency markets overnight. The spokesman added that the BOE was “looking into” the causes of the currency’s dramatic crash.
The most likely cause of the pound’s sudden drop on Friday was a so-called “fat finger” trade—that is, an error by a trader—or a rogue algorithm, said Bart Wakabayashi, managing director and head of Hong Kong foreign exchange sales at State Street Global Markets.
“When you have that big a move you’re triggering a lot of things on the way down, like stop losses and options barriers, which exacerbate the whole move,” said Mr. Wakabayashi, who added he expected the pound would head back up toward its starting level on Friday in the near-term.
—Vera Sprothen, Mia Lamar, Hiroyuki Kachi, James Glynn and Mike Bird contributed to this article.
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