Patchy liquidity and the lack of pre-positioning cannot alone account for why we get some wild moves in markets – sometimes the liquidity providers should wear some of the blame. How else do we explain spreads in Cable that are almost as wide as the entire range this decade?
The lack of incentive to take any risk doesn't help, but what justification can a market maker have for quoting 50 big figures wide? At that spread, they might as well pull out of the market altogether.
Monday’s column touched a nerve with its criticism of market makers that quote ridiculously large spreads. Of course, we should also question the quality of controls at a participant that allows someone (or something) to hit a big 35 big figures below the last price.
Going back to market makers though, perhaps we need, using the execution quality analytics now available, to start naming and shaming the worst offenders? I personally have no problem with this and I think I would have quite a bit of support.
A new research note from Pragma Securities is seeking to challenge the perception that banks are increasingly stepping back from providing liquidity to FX markets.
The firm notes in the paper that the “typical narrative” is that
reduced appetite for risk, controls on
capital at banks, as well as juniorisation of dealer staff have all contributed to this withdrawal that led to an “increased fragility of the FX markets”. The paper adds that the general consensus seems
to be that liquidity is getting more expensive, and while spreads are
narrow in times of normal volatility, in
times of market stress dealers effectively pull away from the markets, contributing to extreme volatility and events like flash crashes.
The communications channels have been buzzing following Thursday's column about banks taking more risk in their FICC businesses - especially FX - and some really good points were made by correspondents. But while there was general agreement that more risk-takers would benefit the broader industry, my correspondents and I diverged on a key point. To me this is not about spreads or the advantage of man over machine (or vice versa), it is about the risk taking role adding something different.