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[SYDNEY] The $5.3-trillion currency market is getting harder for traders to make money in as price changes that once took months or weeks now happen more quickly, says Hugh Killen, Westpac Banking Corp's head of trading for foreign exchange, fixed income and commodities.
Liquidity is drying up because investors and banks are shying away from taking risk, and that makes for sharper, quicker currency turns, said Killen, whose career in financial markets spans 27 years and positions in Sydney, London and New York. While volatility - which typically helps traders profit from price swings - has increased since 2014, turnover in October dropped to the lowest level in three years in the UK, the main currency trading centre. The reduced volumes came as a series of policy surprises rattled investors, from the lifting of the Swiss National Bank's currency cap to China's yuan devaluation and the Bank of Japan's unexpected easing.
"Where it may have taken months or weeks for prices to adjust, it happens very quickly now," said Sydney-based Killen, who joined Australia's second-biggest lender in 2001. "It's these kinds of moves that are creating a bit of stress and whatever risk capital is being deployed can get wiped out very quickly." A case in point is the yen: It dropped the most in more than a year on Jan 29 after BOJ Governor Haruhiko Kuroda unexpectedly adopted negative rates. It has surged more than 6 per cent since, set for its steepest monthly advance since 2008. Likewise, the euro has seen a weekly gain of 3 per cent or more on three occasions since the start of 2015 and dropped as much five times. There were no comparable moves in the prior three years.
"We're now starting to play a lot at the extremes of the ranges, and what I mean by that is that the market not only mean reverts, but goes back through to the other side of the price very quickly," said Killen. "So really, you've got these whipsaws between ranges." The yen traded at 113.96 per dollar as of 7:17 am in Tokyo on Monday after appreciating to 110.99 on Feb 11, the strongest level since October 2014. Three-month implied volatility climbed to a 2 1/2-year high on the day the yen peaked as traders digested the nearly 10 per cent move from Jan 29's low of 121.69.
Europe's common currency bought $1.0918, climbing 3.7 per cent from an almost eight-month low reached in December.
Diminishing liquidity - or the prospects of it drying up during times of stress - dominated discussions at this month's TradeTech FX conference in Miami as fund managers sought answers to a string of so-called flash crashes that have hit currency markets in recent months. During volatile periods, market participants are backing away until conditions settle down, Collin Crownover, head of currency management at State Street Global Advisors Inc, which oversees about US$2.4 trillion, said at the conference. "A lot of the electronification of the market, which by and large is a good thing, has led to kill switches on a lot of that algorithmic-provided liquidity." Average daily turnover in the UK dropped 21 per cent in October from a year earlier while volumes in North America slid 26 per cent, according to central banks in the two regions. A JPMorgan Chase & Co gauge of volatility climbed to its highest level in four years this month, more than doubling from the unprecedented lows reached in mid-2014.
At the same time, a decline in currency trading revenues and the rising cost of regulatory change have forced banks to turn to increased automation and cut staff. There were 2,300 people working in currency-market front-office jobs at the world's biggest banks in 2014, a 23 per cent drop from four years earlier, according to Coalition Development Ltd., an analytics firm.
"The FX market continues to automate rapidly as it reacts to disruptive technology and regulation," said Killen. "A positive impact being that participants can now hedge and follow market moves much more efficiently than when the traders were largely analog."
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