We previously reported that according to the latest BIS Triennial Central Bank survey, spot FX volumes fell 17% to $1.7 trillion from $2 trillion, the first time volumes have fallen since 2001. The drop was even more acute in the realm of hedge funds and proprietary trading firms, where volumes tumbled by more than 30% over the past three years.
There were various explanations for this: David Mechner, CEO at algo trading firm Pragma Securities, said that “the market has undergone a period of significant change, driven in part by allegations of trader misbehaviour and the subsequent development of a global code of conduct, but also by shifting attitudes within banks to allocate capital as efficiently as possible in light of ongoing regulatory constraints.” JPM added that “the shrinkage in the share of FX trading by these investors is likely the result of regulatory pressures and FX rigging investigations which caused significant retrenchment by FX prop desks.”
In other words, JPM suggested that if one can’t trade a rigged market, one simply does not trade, period.
While that cynical explanation may be right – especially coming from JPM – overnight Bloomberg’s Richard Breslow has come up with a different, even more pragmatic explanation. In a note titled, “Investors Not Rewarded by High Difficulty Level”, the Bloomberg commentator makes the following simple argument:
Why beat your head against the wall trying to make sense of some stretched argument about how the Russian ruble will fare against the South African rand when simply buying gold has been the alternative?
The former has multiple, opaque and rapidly changing parts galore. The latter only requires evaluating if the world will stay as messed up as it’s become.
Since this confirms what we have said for years, namely that central banks distorting, and in recent months, outright nationalizing capital markets (as the BOJ has done with Japanese ETFs, and thus equities) is forcing disgusted traders to exit any market where nothing makes sense any more, we would be inclined to say that Breslow is 100% correct.
Here is his full note.
Investors Not Rewarded by High Difficulty Level
A lot has been made of the falling volumes in global foreign exchange turnover. The BIS has put numbers to all of the anecdotal evidence and the decline is real and significant.
Especially as it has come largely at the expense of spot- related flows. Causing liquidity, during crunch times, to really take a hit. Institutional end-users have felt the pain. A sign also that speculative activity is clearly down.
There are a lot of reasonable explanations for this phenomenon. They mostly focus on regulatory changes. Which have led to both intentional and unintended diminution of market-making ability and risk appetite by banks.
Others focus on the disruptive rather than liquidity enhancing activities of high frequency trading. Electronic dealing, both single and multi-dealer platforms, may have improved price discovery at the expense of liquidity on transactions in large amounts. And may have caused divergence from best practices, on both sides of the trade.
But I think the overlooked reality in today’s global trading environment is that, put simply, foreign exchange has just been harder to trade than other asset classes.
Institutional investors, let alone those with the luxury of a family office, go where the environment is most welcoming. Why beat your head against the wall trying to make sense of some stretched argument about how the Russian ruble will fare against the South African rand when simply buying gold has been the alternative?
The former has multiple, opaque and rapidly changing parts galore. The latter only requires evaluating if the world will stay as messed up as it’s become.
Unconventional monetary policy has completely altered the portfolio selection calculus. Front-running central bank feeding frenzies is the trading ticket.
Not to mention the unintuitive consequences of policies like negative rates causing currencies to appreciate. That was hard to trade in prospect. Buying corporate credit wasn’t.
There are tons of opportunity in currency trading. But trends, such as there have been, have been hard to capture. Traders have, logically, chosen the opportunities with the lowest difficulty levels. Unlike in the Olympics there’s no penalty for doing so.
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