It is starting to look like last year was not an aberration in the FX
industry and that the volume profile of the industry is going to remain
volatile for some time to come.
This is not an especially major issue in itself, the FX market has long been
characterised by extended periods of feast and famine when it comes to
activity, but what is a concern is how the “famine” periods are at a much lower
level than previously. Put simply, a lot of volume appears to have left the
It is not as though there are no events to drive matters. The random
messages coming out of the White House did serve as a source of optimism for
those hoping for a surge in activity, but it has become clear over the last
month that the markets are starting to ignore them.
What I find intriguing is how the Federal Reserve seems set on hiking
rates at this month’s meeting and even that hasn’t had much of an impact.
Looking at the markets this morning the dollar was slightly lower than
pre-Janet Yellen levels (but generally rates are at depressingly familiar
The driver of this is without doubt the modern phenomena, as highlighted
by Citi’s Steven Englander last year, that is the lack of pre-positioning in
markets. People seem content to wait for something to happen and then jump on
Assuming they are in the first three or four through the metaphorical
exit door, traders can make money – the rest are merely providing fodder for
market makers who have already priced the news in.
Traders are reluctant – or certainly not encouraged – to take risk ahead
of events, which doesn’t help. Again I come back to one of the themes of the moment – the lack of incentive to do anything
that could be termed “brave”.
But if this is actually the case, and people are not taking risk ahead of
known events, then how do they expect to make money? Is the FX market now
sufficiently dominated by short term traders happy to nick a few points out of
a 100 point move, that it doesn’t matter people aren’t making serious money?
It should matter, especially for those in the volume game like the major
market makers and, of course, the trading venue providers, for we appear to be
stuck in a situation wherein markets are either quiet enough that speed traders
benefit from their arbitrage strategies (to the detriment of other traders who
don’t get involved), or too busy to get anything actually done because market
makers are pricing extremely defensively.
I understand market making is not a charity and everyone has to earn a
dollar, but some of the stories I hear about spreads around events are, quite
During the sterling flash crash I have been shown data that indicates
some market makers – that no doubt would stress they were there throughout the
event – who were quoting 30 to 50 big
I know I have, in the past, suggested that when the world is collapsing
around your ears any bid is a good bid, but on October 7, one participant was
made a 0.75-1.25 price in Cable. Quite
honestly, there is no point in that market maker bothering.
I suspect this is another manifestation of what happens when prices and
spreads are dictated by machine logic – the price engine couldn’t see a bid,
the defense mechanisms cut in, helped by inexperienced traders supporting a
widening of spreads, and all of a sudden we are 5000 points wide.
The problem is, yet again, the fear factor that exists in markets. The
aforementioned market maker doesn’t want to stand accused of pulling the plug on
its customers or relationships, so it spreads so wide as to make it impossible
to hit the price (but of course it does get hit occasionally and we go back to
There is, of course, no answer to this problem, but if it continues,
inevitably the number of participants interested in FX will dwindle, that low
base of volume will shift even lower. And that will be bad for everyone –
including the market makers contributing to the problem with their short-sighted
I have been in foreign exchange nearly 40 years and I am struggling to
think of a single event that would require a price in Cable 50 big figures
wide. To put that into numbers, that is a million dollar spread on just GBP 2
When the UK announced it was leaving the European Rate Mechanism in 1992
sterling dropped some 12 big figures against the Deutsche mark immediately
following the announcement.
Likewise, if my memory serves me correctly, after the Plaza Accord in
1985 (which was announced over a weekend), the dollar fell some 15 big figures
against the Deutsche mark. In both cases the fall, following events that were
known to everyone – was around the 5% mark. Yes, both currency pairs fell much
further in coming days, but generally they did so in an orderly fashion.
Cable obviously fell further than 5% on October 7, but even so the 11 big
figure drop cannot in any way justify spreads of 30-50 big figures. What makes it worse is they were probably quoting those spreads with last look – can it get any worse?
I think it is fair to argue that not only did a panicking trader and the
wrong algo strategy exacerbate the flash crash, but so too did the ridiculously
over the top reaction of some market makers who pushed spreads to stupidly wide
The FX industry has always prided itself on its professionalism and
generally speaking I think it remains a very professional business populated by
people who try to do the right thing at all times.
Clearly, however, there are some who don’t understand responsibility or professionalism
because I would very much like to know the circumstances under which it is
acceptable to quote a spread (and probably for 3 million units at most) that
represents more than the entire range traded by Cable this decade.