One of my all-time favorite financial books is Roger Lowenstein’s seminal volume, “When Genius Failed: The Rise and Fall of Long-Term Capital Management.” The book recounts the rise and fall of Long-Term Capital Management (LTCM), a wildly popular hedge fund made up of an all-star team of Nobel-Prize-winning PhDs, central bankers, and traders. As the title implies, the venture eventually collapsed in the late ‘90s, and one of the primary catalysts of the collapse was a crisis in emerging market FX.
The ’97-‘98 EM FX crisis began in Southeast Asia, but eventually spread to larger and more significant currencies like the Russian ruble. In an eerie parallel to today, the ruble was particularly vulnerable to a panic due to debts built up after a war with a former soviet neighbor (Chechnya then, Ukraine now), an above-market managed exchange rate (recently abandoned by Russia’s central bank), and falling oil prices.
Flashing forward to today, the ruble has been absolutely demolished. Russia’s currency has shed an incredible 14% of its value against the dollar in less than 24 hours, driving USD/RUB from 58.00 to 66.00 this week alone. There’s no obvious fundamental catalyst for such a dramatic move; instead traders’ collective greed and fear is driving the ruble today. Where else can you find a currency that is capable of moving so much in just one day? Certainly not the EUR/USD, as I noted on twitter earlier.
At this point, traders can sense blood in the water, and they will continue to sell the ruble until something causes them to stop. As we saw earlier this year in Turkey and South Africa, the best way to restore faith in a currency is through decisive action on the part of policymakers. Clearly, last week’s 100bps hike from Russia’s central bank was not sufficient.
While there’s no guarantee that direct FX intervention, currency controls, or an emergency central bank meeting will be effective in Russia this time, policymakers will feel obligated to act soon; they can hardly sit idly by and watch their populace become 14% poorer overnight. Therefore, we would not be surprised to see some policy action in today’s Asian session, so USD/RUB bulls may want to tread carefully and be nimble with their trades.
Indeed, there are even signs that the ruble’s crisis is becoming contagious. Today’s panic appears to be crossing the Black Sea to Turkey, with USD/TRY peeking out to a new all-time high amidst Turkey’s own geopolitical concerns.
As a final note, the most important lesson to draw from “When Genius Failed” is that excessive leverage can ruin even the smartest of traders; while I doubt any of our readers are Nobel Prize winners, limiting leverage (especially during times of excessive volatility, as today) is a simple way to reduce the risk of a trading implosion!
Source: FOREX.com
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