Fast forex moves raise liquidity worries

08/04/2015 08:13 AST

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For a market that trades a notional average of $5.3tn a day, foreign exchange is currently bedevilled by a perplexing problem: what has happened to market liquidity?

In recent months a series of dramatic and unforeseen intraday fluctuations — even in popular and widely traded currencies — has led forex investors, bank traders and analysts to question the mechanics of the market.

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At its heart is a question of whether the vast over-the-counter (OTC) market, long dominated by just a handful of large investment banks conducting trades, is in a cyclical decline or just the latest to be affected by new technology and tough regulation enforcing change.

The broader concern is that declining liquidity will fuel more sudden forex moves and destabilise the market. According to Standard Bank’s G10 currency strategist Steven Barrow, “volatility and spikes borne out of aggressive reactions to perhaps not very startling moves can drive currencies away from fundamentals”.

Many fear it is already happening. Matthew Cobon, a fund manager at Threadneedle Asset Management, left his office late on March 18 when the euro was worth $1.08. At the end of his 15-minute trip home, the euro had jumped to $1.10. It took place in the hours after US Federal Reserve chairwoman Janet Yellen signalled a not-unexpected dovish approach to monetary policy. And yet, says Mr Cobon, “there was little traded on the spike to $1.10”. The following day, the jump had been unwound.

CLS, the London-based, US regulated settlement system used by much of the forex market, recorded a 16.5 per cent fall in February average daily volumes compared with January — though that month did witness extreme volatility caused by the Swiss National Bank abandoning the Swiss franc’s peg to the euro.

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Financial Times