FX Realignment 2019

What was termed the “Flash Crash ” last week in actuality was a rarely seen, rarely known event that occurs every 10 years in FX markets known as Realignment. Realignment pertains specifically to FX cross pairs and involves an allegiance switch to and from underlying USD and Non USD anchor currency pairs.

Interest in the realignment topic derives from a 10,000 exchange rate study against deeply explained Regression Statistics between the 1998 and 2008 realignments and published in an academic journal under a double blind review. UBS is the only bank to ever devote words to this issue in post 2008 trading and not many words.

Previous Realignments since the 1972 free float transpired in 2008, 1998 and speculation to 1987. Year 2019 begins a new Realignment period to signify not only a new episodic cycle but fresh trends are upon us. Fresh trends in currency markets are highlighted for example by 10 year periods, 10 year trend trades such as EUR/USD at 1.6000 in 2008 to the 1.0300 bottom within a 9 year time frame.

The 500 pip drop last week led by EUR/JPY break at 124.13 was the message to markets to alert not only is Realignment upon us but shorts was the way upon the break. EUR/JPY as preeminent widely traded cross pair since year 2000 led the 1998, 2008 and now 2019 Realignment periods. EUR/JPY will lead the charge in markets moving forward as well as to adjust the previous 10 year Carry Trades and hedges. What worked in the past, won’t work in the future 10 years to new periodic markets.

Why the term Flash Crash under a sudden 500 pip drop is because previous 1987, 1998, and 2008 Realignments involved market implosions driven by an outside event. Wide swing Pip movements were easily explainable by the event. The current 2019 Realignment was driven by a specific point break, lacked any association to implosion and caught market traders completely off guard unless traders understood EUR/JPY’s significance to 124.13.

The side issue mentioned in my paper was the question does Realignment always involve a market crash or will Realignment signify by a specific point break and the years long awaited answer is for the first time since 1972, a point break is enough for a realignment. Quite a historic event.

Realignment must be viewed, statistically calculated and traded based on a 3 pair FX combination. The best example is seen in most widely traded EUR/USD, EUR/JPY and USD/JPY. Yet any 3 pair combinations work such as GBP/USD, GBP/JPY and USD/JPY or GBP/USD, GBP/CHF and USD/CHF.

Many aspects to Regression Statistics are available to not only explain Realignments but to see realignment coming as well as future trades miles in advance. Statistically and to explain simply, Cross pair realignment is a Correlation shift seen most specifically in Correlations, Co -variance and RHO as the confidence interval to Correlations.

EUR/JPY for example is seen a top and bottom to its association to EUR/USD and /or USD/JPY. EUR/JPY began its Correlation association to EUR/USD in 1998, switched to USD/JPY in 2008 and now will switch back again to EUR/USD for a 10 year duration until the next realignment.

Was the 500 pip move enough to declare the complete correlation change is yet unknown and under the assumption the change was not complete because prior full realignments took almost 1 year to finish. Traditional Correlation changes involves specific switches to either an exact pip or small range. Important is we are in the threshold to new trends.

EUR/USD and EUR/JPY Correlation associations will see greater market volatility as opposed to less volatility associated to EUR/JPY and USD/JPY. Greater volatility as EUR/USD and EUR/JPY is naturally by statistics built into exchange rate numbers to allow wider trading boundaries as opposed to the far less boundaries as EUR/JPY and USD/JPY. Market departments in central banks are responsible to assign exchange rate numbers.

The key moving forward is 10 year trends, 10 year duration against 10 year averages.

 

Brian Twomey,

 

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