Author: Gordon Platt

It is a changing world for FX traders. Regulatory uncertainty and low volatility are putting a damper on the foreign exchange market, with spreads narrowing by 20% already this year—to record lows. FX trading volume is approaching the lowest level in the history of free-floating exchange rates, notes George Saravelos, currencies analyst at Deutsche Bank. Floating rates were introduced more than 40 years ago, after US president Richard Nixon ended the direct convertibility of the dollar into gold.

Many banks have closed down their proprietary trading desks in reaction to the Volcker Rule. And in the UK, the Serious Fraud Office began a criminal investigation in July into alleged rigging of the FX market. These are just a couple of the many pressures now acting on the FX markets.

“Lower transaction costs may lead to lower volatility as markets reach equilibrium faster,” Saravelos says. Regulatory changes and scrutiny are also shifting volume away from interbank voice trading and toward electronic platforms, he adds. Volume on Thomson Reuters’ FXall, a multidealer platform, averaged $141 billion daily in June, the highest on record. Phil Weisberg, global head of foreign exchange at Thomson Reuters, says: “Expectations in the FX market were that trading volumes would be subdued due to the extended period of low volatility. Our FX platforms [matching, dealing and Reuters Trading for FX, as well as FXall] nevertheless traded a robust average
$235 billion daily throughout June.”

The firm’s overall trading volume in July was up 8% from a year earlier. “It was a strong follow-up to a spectacular June,” Weisberg says. “The market consensus is that trading is slowing, but our strength is that we are diversified, offering a range of transaction types across FX.”

The spot, or cash FX, market appears to have had a bigger slowdown than currency swaps and forwards in recent months. The latest semiannual FX volume survey by the Foreign Exchange Committee of the Federal Reserve Bank of New York, which was issued in April, showed a decline of more than 32% from a year earlier in US spot transactions. Forward FX transactions were up 2.5% in the same period, while swaps were down 7.9%.

In London the Foreign Exchange Joint Standing Committee of the Bank of England said average daily FX turnover in April was 6% below the record highs of a year earlier. FX spot turnover in the UK was down 21% in the same period, while FX swap turnover continued to rise to a new survey high of more than $1.2 trillion a day.

David Rodriguez, quantitative strategist at news and research firm DailyFX, says there are risks below the surface for currency traders as FX volatility falls near record lows. He notes: “Clearly, many traders fear the next major currency move is just around the corner, and any especially crowded trades seem at risk, as speculators will flee at the first sign of danger.”

Professional traders were holding extreme short positions in the euro against the dollar in early August, betting that the euro would decline. “Any surprises can clearly spark outsized moves,” Rodriguez says.