New Zealand Dollar Has Most Volatile Day Since Dec. 1985, But Why?

Kiwi Coin NZD
The Unique Flightless Bird of NZ.

The last week of August 2015 began with the day that earned the moniker  'Black Monday' . Black Monday got the name because the Dow Jones industrial average dropped by its most points intraday in the history of nearly 1100 points. Surprisingly, after multiple rounds government intervention and strong US economic data, markets that were in full panic mode on Monday closed higher on the week as of Friday.

However, a peculiar victim of black Monday and the illiquidity within was the New Zealand dollar also known as the flightless national bird, the Kiwi. 

As markets were seemingly coming apart at the seams on Monday around the US equity market open, the New Zealand dollar plunged due to lack of liquidity by the sharpest amount in 30 years. On January 15, the Swiss franc strengthened by nearly 20% in a matter of seconds as the Swiss national Bank waived their white flag on supporting the euro and preventing further gains in the Swiss franc. The late August move in New Zealand dollar was a mirror opposite of that because buyers were nowhere to be found as the market dropped nearly 400 pips or four US cents in a matter of minutes singing intraday loss of 8 1/2% before bouncing back to the prior levels seen before the plunge.

Market Micro-Structure

As noted above,  the recent developments in Spot FX markets this year have shown a decrease which affects liquidity alongside an increased volatility.

When you look at the structure of the market, which is without a centralized exchange you can see why these are inversely correlated. First to note, the New Zealand dollar and all other currencies are typically quoted by banks who are risk analyzing entities. In other words, while futures are in certain the quantification of risk and wind it's worth taking is said to be their specialty.

However, on events like black Monday, banks see less upside in providing liquidity or market pricing than they do and simply stopping providing pricing and order flow.

An exchange, like the New York Stock Exchange, is designated for steady flows of orders regardless of the news. Because the foreign exchange market does not have a centralized exchange, liquidity problems arise when volatility gets out of hand. This tends to create a vacuum like a fact, which we've seen during the Fukushima tsunami, the Swiss National Bank peg removal and most recently, Black Monday.

The Most Liquid Market In The World?

When a Forex trader comes to the market, they are often first told that more money changes hands in the FX market than all other publicly traded markets. The Bank of international settlements in Zürich Switzerland recently tallied the daily trade flow to the tune of $5.5 trillion. When first hearing these astronomical numbers, it's understandable that one would think orders would be executed without problem. However, while getting an order filled may be possible the difficulty comes in finding an appropriate bid or offer when needed if volatility spikes.

Why The Diminishing Echoes Of Foreign Exchange Spot Liquidity

The difference between the cheapest by price and the most expensive cell priced is known as the spread.

Brokers, like FXCM, pride themselves on developing relationships with multiple liquidity providers so that an aggressive spread may be quoted to the trader when the market is open. However, the spread is dictated by the liquidity providers that are risk analyzing banks as mentioned above. Due to the culmination of fear on Monday morning specifically, the aggressive bids and aggressive offers became noticeably less aggressive which cause the spread of NZDUSD normally trades around 1 pip or less, had an almost 200 pip and likely at very small pools or tiers of liquidity. In other words, even if you saw the price, if you put in an order for 1 million and the most aggressive bank is only offering 750,000, your order either will not get filled or get chopped up down the tears of liquidity creating a frustrating order fill.

·In summary, as markets try to assess what is on the other side of this global growth slowdown, liquidity providers may become increasingly less competitive and spreads may widen. It is important to have stop-loss orders and trade with low leverage is volatility increases. In the end, you are responsible for your exposure to anyone trade and markets often do not behave as you wish they would when the panic starts.

Disclaimer: Tyler Yell, CMT is employed by Forex Capital Markets, FXCM