Global Outlook 2024 Report


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Foreign exchange: a ‘perfect storm’ of growth driven by HFs

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A “perfect storm” of market volatility drove up global foreign exchange trading volumes by nearly 25 per cent in 2004, according to Greenwich Associates.

Riding th

A “perfect storm” of market volatility drove up global foreign exchange trading volumes by nearly 25 per cent in 2004, according to Greenwich Associates.

Riding this wave – and generating much of the volume growth – has been a new class of “professional” FX investors, many of whom are hedge funds.

A new Greenwich Associates report analyzes the impressive growth of foreign exchange trading volumes and other trends in global FX. The report also examines developments in the interest-rate derivatives market, where a combination of stable interest rates and low levels of corporate bond issuance have depressed trading volumes.

Additionally, the report presents Greenwich Associates’ latest research among financial institutions and the treasury departments of global corporations, including the most recent findings regarding the compensation levels of corporate treasury professionals around the world.

New “Pros” Drive FX Growth

The massive increase in FX trading volumes seen over the past 12 months can be attributed in part to cyclical factors obvious to anyone watching the evening news: the war in Iraq, terrorism, fluctuations in the value of the US dollar, and rapidly rising commodities prices. Also contributing to the volume growth however, were the active trading strategies employed by hedge funds and asset managers looking to capitalize on these high volatility levels.

“Financial institutions and non-traditional FX users are accounting for a growing proportion of foreign exchange trading volume,” says Greenwich Associates consultant Woody Canaday. “The changes that are occurring in global FX have been so profound that the market has begun to evolve from its origin as a by-product of international trade and international capital markets transactions to an asset class in itself.”

Bonanza for hedge funds

While the relatively lacklustre performance of traditional investment markets such as stocks and bonds has encouraged an increasing number of “real money” asset managers and retail players to trade foreign exchange as an independent asset class, the most prominent members of this new breed of professional FX investors are hedge funds.

“When you combine last year’s dollar volatility with the drastic ups and downs in pricing for commodities – which are priced in dollars – you produce nothing short of a currency volatility bonanza for hedge funds,” says Greenwich Associates consultant Frank Feenstra.

Banks also accounted for a large portion of total FX volume growth in 2004. “The migration of smaller banks from the professional interbank market to the customer market was another big driver behind the growth in trading volumes in 2004,” says Greenwich Associates consultant Peter D’Amario.

Temporary reaction?

While trading volumes have increased throughout the foreign exchange markets – including among corporates – Greenwich Associates consultant Tim Sangston says it is too early to tell if the market can maintain this level of activity.

“Market conditions have attracted a swarm of active FX traders, but until volatility levels fall, it remains to be seen whether the development of this new class of investor is a temporary reaction to current volatility levels, or if it is a secular change to the composition and behavior of the FX investor base.”

Global growth

Europe accounts for the majority of global FX volume, or roughly 60 per cent in 2004, and the highest rate of year-to-year growth in average foreign exchange trading volumes was found in the United Kingdom. On a matched sample basis, average volume in the United Kingdom rose from USD 38.9 billion in 2004 to USD 55.4 billion in 2005 – an increase of some 42 per cent.

Trade volumes in the United States followed a similar trajectory, with average volumes rising 39 per cent from USD 39.2 billion to USD 54.5 billion.

Volume growth in other regions – while falling short of that of the U.K. and the US – was nevertheless robust. Average continental European trading volumes rose from USD 35.4 billion to USD 41.7, or 18per cent.

In Latin America, volumes grew from USD 15.1 billion to USD 16.2 billion, or 7 per cent. In Canada, average trading volume increased 4.6 per cent, from USD 18.6 billion to USD 19.5 billion, and average trading volumes in Asia ex-Japan rose from USD 20.9 billion to USD 21.4 billion, or slightly more than 2 per cent. The only year-to-year decrease occurred in Japan, where average trading volumes declined by more than 6 per cent.

“There is one reason that the biggest increases in average FX trading volumes occurred in the UK and the US,” says Greenwich Associates consultant Robert Statius-Muller. “A disproportionate number of hedge funds are domiciled there.”

Interest-rate derivatives: trading still sluggish

A stable interest-rate environment, sluggish corporate bond issuance and the adoption of tighter accounting standards in several markets last year pushed down buy-side trading volume in interest-rate derivatives for the third year in a row.

Interest-rate derivatives trading volume among corporate and government accounts fell by more than 12 per cent from 2003 to 2004, with significant volume decreases reported in nearly every major market except Europe. Asia saw the biggest fall, with year-to-year volume dropping almost 29 per cent, while reported volumes in the United States, the United Kingdom and Japan fell approximately 22 per cent. Interest-rate derivatives fared slightly better in Europe, where volumes declined by only about 3 per cent.

Much of these declines can be attributed to the stability of global interest rates, which has reduced hedging incentives. “While short-term rates in the U.S. have been rising, they have been doing so at a deliberate and measured pace that discourages speculation,” says Greenwich Associates consultant Lea Hansen. “And their counterparts in Europe, Japan and most other areas have been, from a speculative viewpoint, almost tediously low and stable. In addition, long-term rates stubbornly refused to rise.”


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