Pound’s shocking drop is ‘part of the new normal’

October 7, 2016 CNBC

By: Evelyn Cheng

The overnight plunge in the British pound is an example of a once-rare event that may soon become more frequent in currency markets, several analysts say. And wider volatility may follow.

Marc Chandler, global head of currency strategy at Brown Brothers Harriman, said he’s seen only about 10 instances of such sharp moves in a currency in the last few decades. But similar market gyrations could become more frequent among important currencies, given the pound’s two large drops so far this year against the dollar, and the Swiss franc’s surge against the dollar in January 2015 after the Swiss National Bank abandoned its euro peg.

“This is part of the new normal,” he said.

“It stresses the entire system,” Adam Button, currency analyst at ForexLive.com, said of the pound’s dive. He added that currency markets aren’t “made for 6-percent moves.”

“It’s another one-in-a-hundred-year event, and we seem to get one or two of them a year. It’s a lesson for risk in any kind of market,” he said. “This is the first salvo of volatility. I think it’s coming to bonds. I think it’s coming to stocks.”

After one of the worst starts to a year in memory and a brief sell-off following the UK’s surprise vote in June to leave the European Union, U.S. stocks and global currencies had a relatively stable summer. The S&P 500 crept higher to record levels in a string of sub-1 percent daily moves, while other assets such as currencies and bonds have mostly remained in a trading range.

“I think we’ve transitioned out of the low volatility environment that characterized the early part of the year,” said Karl Schamotta, head of enterprise risk management at Cambridge Global Payments.

Pound vs. US dollar since 1972

Schamotta said upcoming events that could produce market swings this year include the U.S. presidential election, a possible U.S. Federal Reserve rate hike, and December’s Italian referendum on constitutional reform, which he said “looks like a particular trigger that many (market) participants look to hedge levels against.”

The Italian referendum could raise further questions on the future of the euro zone, because Italy’s Prime Minister Matteo Renzi has said he would resign if the constitutional reforms are not passed. There are fears that his departure could lead to a populist party coming to power in Italy, which is already in the midst of a banking crisis. (Italians are voting to decide whether to streamline their law-making process.)

Ahead of those potential market-moving events, pound sterling suddenly dropped Thursday evening New York time from around $1.26 to $1.145, a fresh low going back to 1985, according to Reuters.

There was no specific trigger behind the more than 9 percent snap lower, analysts said. They pointed to a lack of buyers and sellers in the hours between the U.S. market close and the Asia open, and automated selling pressure from computer programs as the pound broke below key levels.

Sterling has been under pressure all week amid renewed focus on the U.K. vote to leave the European Union on June 23, which knocked the pound from roughly $1.50 to around $1.30.

Last weekend, U.K. Prime Minister Theresa May said that the nation would begin the official process of leaving the EU “no later than the end of March.” Subsequent headlines have raised market concerns about a serious break in U.K. and European Union trade relations, or a so-called “hard” Brexit, versus previous hopes that negotiations would essentially preserve the existing economic relationship.

Then overnight Thursday, French President Francois Hollande indicated in strong terms that the United Kingdom should face consequences for the Brexit vote. “There must be a price,” Hollande said.

Read the full article here: http://www.cnbc.com/2016/10/07/pounds-shocking-drop-is-part-of-the-new-normal-could-affect-other-markets.html