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What’s Behind the FX Market’s New Benchmark?

While there is little surprise at the new benchmark for FX
activity set by the Bank for International Settlements, there have been a few
eyebrows raised at the increase in activity in Asia, especially in FX swaps,
which the BIS survey highlights as a driver.

The evidence from the past year or 18 months has been an FX
market at low ebb – spot volumes reported and anecdotal have pointed to a
slowdown in activity which has been realised, but the growth in swaps has
caught some out.

The answer to what is driving activity can be found in the
recent FX committee semi-annual surveys which indicated, according to Profit & Loss analysis, a number in
the region of $5 trillion from the BIS report. Within those reports Singapore
and Japan saw significant growth, almost entirely in FX swaps.

Until the final BIS report is released in December the FX
committee surveys offer the best indication of the components that led to just
under $5.1 trillion. These show that turnover in Japan rose by 16% from April
2013-2016 and Singapore grew by 33%.

In both cases yen swaps were the main driver, followed by
euro FX swaps. The Singapore FX committee data, which is collated differently
to the BIS (according to the location of the trading desk rather than the
latter’s location of the sales desk) indicated that yen FX swap volume had, on
a gross monthly basis, risen by over 300% in the three years to April 2016.

In Japan, the Tokyo committee’s report indicated a 31% increase
in FX swap activity across April 2013-16 as well as a 87% increase in outright
forward activity.

It is interesting that the BIS report makes a point of
recalling the surge in yen activity that characterised the April 2013 report
for the same can be said for the latest survey. Although market sources are
mystified over why Singapore saw so much of the action, they are less surprised
that yen swaps activity was much higher.

In April of this year expectations steadily grew that the
Bank of Japan was going to further ease monetary policy at its meeting on April
28. Market sources say the speculators and hedgers alike were actively covering
the forward exposures for just that event, leading to higher trading volumes. In turn banks were less willing to hold forward positions in the yen so often back-to-backed customer trading into the market rather than risk warehousing it.

What actually happened was the Bank of Japan did nothing –
much to general surprise – which in turn saw a sharp reversal on position
squaring. There is a theory that the surge in Singapore yen swaps activity was
focused at the very end of the survey month as Japan started its annual Golden Week
holiday on April 29, so just when much of the position squaring was taking
place, Japan’s markets were closed.

Colin_lambert@profit-loss.com

Twitter @lamboPnL

Twitter @Profit_and_Loss

Colin Lambert

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