Falling FX volumes down to policymaker interference

By:
Peter Garnham
Published on:

The drop-off in FX volumes witnessed during the past month is the result of investor resignation over political interference in the market.

That is the warning from Sweden’s SEB, which sees little reason to predict a pick-up in activity.

The call comes as figures from Icap’s EBS electronic platform showed average daily FX trading volumes were down 17% on the month and 46% on the year in October, at a record low of $92.6 billion.

Falling volumes were also recorded at other leading platforms, with Thomson Reuters and CME Group both witnessing a drop-off in trading last month.

Carl Hammer, head of FX strategy at SEB, says lower FX market activity might be one reason why price movements in various currency pairs, as measured by realized volatility, have hit multi-year lows.

Indeed, three-month realized volatility between the most-traded global currencies and the USD, as pictured below, stands at 7.6%, well below its pre-financial crisis average of 9.2%.

 FX market realized volatility versus USD
G9 currencies against USD

 
 Source: SEB

Hammer says usually he would expect such low volatility to occur in a stable and predictable environment governed by strong trends, similar to those that existed in the FX markets in 2006 and 2007.

"However, currently it is difficult to argue that financial markets are highly predictable," he says.

"Instead, they and financial asset prices in general are being manipulated by central bank policy and are highly sensitive to extremely hard-to-forecast political decisions."

Hammer says new regulations have reduced the ability of key players such as banks to participate in the market, given the clampdown on proprietary trading, while the unpredictable effects of new regulation add to the uncertainty.

"As a result of the increased political involvement, it has become extremely difficult for investors to formulate a qualified opinion concerning what constitutes a reasonable financial asset valuation," says Hammer.

"We therefore regard current falling volumes and decreasing price volatility as probably reflecting growing resignation among investors, leading them to simply reduce exposure and market participation as the expected return no longer can be justified, considering the risks."