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Near-record low levels of volatility are undermining confidence among the largest players about prospects for foreign exchange trading in the months ahead, according to this year’s Euromoney Pulse Survey, released in association with Thomson Reuters.
Some 53% of the 15 largest buyside firms (accounting for $5 trillion of trades last year) say they are not as confident about trading FX as they were two years ago. That number contrasts with smaller players, some 37% of which say they are not as confident as they were in 2012.
With the US Federal Reserve still in the early stages of monetary tightening, FX investors are in wait-and-see mode, a state of affairs that is consistent with the start of previous Fed hiking cycles, according to Bank of America Merrill Lynch (BAML).
Looking for direction
“Looking back to the start of the previous Fed hiking cycle in June 2004 we find that for a few months following the start of hiking FX volatility fell,” said BAML London-based FX strategist Myria Kyriacou, in a note. “FX ranges and low volatility are consistent with the start, or anticipation, of a withdrawal of monetary stimulus as markets look for clear direction.”
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Mixed data in the US and UK in recent months have created difficult trading conditions but, if past experience is a guide, FX trends are likely to develop as the economy strengthens, Kyriacou said.
“It is too early to anticipate large market moves, but when we start to get a sustained period of strong data, by extension bringing the date of the beginning of tightening closer, we will likely start to see stronger trends emerging. In the meantime, we expect this low volatility, range-bound environment to persist,” she said. This concurs with analysis presented by Ron Leven of Thomson Reuters in the article ‘In the Valley of the Vols’ that appears in the FXExchange2014 supplement to the May issue of Euromoney.
Rising costs
Another area of concern – especially for larger entities – is the rising cost of trading due to thinner liquidity and increased regulation. To cope with the expected regulatory burden, FX market participants plan to beef up technology resources and ensure they are set up for changes in market infrastructure arising from regulation.
Some 80% of survey respondents say they are looking to take on more specialists to address regulatory complexity, with 93% of the 15 largest buyside firms saying that the changing regulatory environment means they need to up-skill the workforce.
New rules under the Dodd-Frank Act and Tobin Tax in the US and European Market Infrastructure Regulation and Markets in Financial Instruments Directive in Europe require increased reporting and record-keeping, monitoring of large positions, new relationships with third-party advisers and mandatory trade reporting. In addition, options and non-deliverable forwards must in the US be executed on swap execution facilities.
The number of electronic venues has grown sharply in the recent period, with 55% of trades and 64% of spot trades executed electronically, compared with just 30% a decade ago, according to BIS data.
Technological change has led to rising operational demands and nearly half of respondents expect to change or take on portfolio management/workflow specialists, while a third of the largest respondents will do the same, suggesting those firms are slightly ahead of the larger group in making those changes.
Alongside investment in staff, IT systems are a key focus, particularly among the largest players where some 85% say they will increase their technology budget.
IT is the biggest area of investment for 36% of firms and 50% of the largest firms, while just over half of the largest firms expect IT to be the most capital-intensive area going forward.
