In a bid to assess the impact of market stress on liquidity, Mosaic Smart Data, a trading analytics company, recently aggregated volume data from foreign exchange settlement firm CLS over two periods, from January 1, 2018, to February 26, 2020, and from February 27 to March 26.
The study found that FX spot transactions were up 41% in March compared with the previous month, with monthly records for EUR/USD, USD/JPY, GBP/USD, USD/CHF and USD/CAD.
However, the more interesting finding was a tendency for the liquidity curve to flatten at 4pm GMT for EUR/USD trading and for a more even distribution of GBP/USD and USD/JPY liquidity during the London afternoon trading session than would be typical.
Currencies of oil-dependent economies have also been hurt by the unprecedented fall in the price of oil
– Simon Manwaring, NatWest Markets
The data showed that the response of market participants to increased volatility and stress was to be more active throughout the day rather than relying on the London fix, in a bid to control trading costs.
“This resulted in a wider, more even distribution of market liquidity, a pattern that so far has remained consistent through April,” says Masami Johnstone, head of information services at CLS.
Less focus on the fix is understandable. The main users of fixings are those for whom benchmarks are most relevant, typically asset managers and leading corporates.
For asset managers, it has been pretty much business as usual during the past couple of months, even though the assets they manage might have experienced substantial volatility. A typical flow would be US equities down 20%, European equities up 10%. Somewhere in the portfolio rebalancing process there would be a euro/dollar trade.
But for corporates, it’s a little more complicated, explains Simon Manwaring, head of currencies trading at NatWest Markets.
“I was talking to the head of treasury at a major retailer recently and he said he had a demand problem in that he didn’t know how much of what customers would buy in an online-only environment, as well as a supply problem in that he didn’t know what would come into his warehouses and when,” he says.
That is a familiar story for corporates in the age of coronavirus. It has disrupted the usually predictable process of corporate cash flows and therefore reduced corporate FX activity.
The availability of tried-and-tested mechanisms for what to do in positive and negative risk environments means that the FX market has not seen any particularly unexpected trading patterns, even though the impact of coronavirus has not been consistent across countries and regions.
CLS saw an increase of $166 billion in EUR/USD traded volumes in the first quarter of the year, which coincided with Italy’s lockdown. During this period, trading activity associated with the sell-off in euros was dominated by the buy side and by funds.
“Money would be expected to flow into dollars and Swiss francs, and away from emerging market currencies, and that has been the story of this crisis as well,” says Manwaring. “Currencies of oil-dependent economies have also been hurt by the unprecedented fall in the price of oil.”
The recent high-volatility environment has shown that platform liquidity is not as durable as might have been expected. It has led to a substantial widening of bid-offer spreads and a reduction in the depth of the market, says Paul Matherne, head of FX trading at BNY Mellon Markets.
“Last year, a good amount of volume could go through at top of book [the best bid/ask],” he explains. “Now we are in an environment where top of book is more shallow.”
Will the market return to normal when coronavirus restrictions are lifted? Matherne says this depends on the definition of normal.
“The period of low volatility was prolonged, but it was not typical of the longer-term deal environment of the FX market,” he says.
“We are familiar with the low-volatility environment, because it is still fresh in our minds and lasted for a long time, but it is more realistic to expect the market to settle somewhere in the middle.”
US to benefit
Non-bank market makers have stepped up their trading activities, and with many of these firms located in the US it is likely that region will see some gains in market share.
That is the view of Vikas Srivastava, chief revenue officer at Integral, who reckons that as traders settle into working remotely in a more distributed way – including distributed working across trading floors – there could be a reduction in the time dedicated to a given trading floor or a specific time zone.
“This may mean we start to see a more even distribution of trading and market making capability across time zones and trading floors in the future,” he says.