FX Market Volume Falls To A Mere $5.1 Trillion Per Day
The Bank of International Settlements carries out the Triennial Central Bank Survey of Foreign Exchange and Derivatives Market Activity, which in 2016 collected data from roughly 1,300 banks and other foreign exchange dealers across 52 countries. Michael Moore, Andreas Schrimpf, and Vladyslav Sushko describe some of the findings in “Downsized FX markets: causes and implications,” which appears in the BIS Quarterly Review (December 2016, pp. 35-51).
The headline finding is that the total turnover in foreign exchange markets dipped from $5.4 trillion per day in the 2013 survey to $5.1 trillion per day in 2016. As the figure shows, there had been a dramatic rise in the volume of foreign exchange trading since about 2000, so the dip is especially notable.
Why the decline? The key point to understand is that most foreign exchange trading isn’t related to exports and imports of goods and services According to the World Trade Organization, total global exports of merchandise and services approached $24 trillion for the entire year of 2014. Clearly, this isn’t going to explain an FX market of $5.1 trillion per day. Moreover, foreign direct investment isn’t the primary drivers of the FX market, either. Foreign direct investment is about $1.0-$1.5 trillion per year.
Instead, the gargantuan FX market is driven by financial investments, both those trying to make money directly from fluctuations in this market, but also those that are buying and selling financial assets in other currencies, as well as hedging the risks of fluctuations in FX rates. Moore, Schrimpf, and Sushko describe in some detail how the FX market is evolving:
Part of the decline in global FX activity can be ascribed to less need for currency trading, as global trade and capital flows have not returned to their pre-Great Financial Crisis (GFC) growth rates. However, conventional macroeconomic drivers alone cannot explain the evolution of FX volumes or their composition across counterparties or instruments. This is because fundamental trading needs only account for a fraction of transactions. Instead, the bulk of turnover reflects inventory risk management by reporting dealers, their clients’ trading strategies and the technology used to execute trades and manage risks. … The composition of participants changed in favour of more risk-averse players. The greater propensity to transact FX for hedging rather than risk-taking purposes by these investors has led to a decoupling of turnover in most FX derivatives from that in spot and options trading. Patterns of liquidity provision and risk-sharing in FX markets have also evolved. The number of dealer banks willing to warehouse risks has declined, while non-bank market-makers have gained a stronger footing as liquidity providers, even trading directly with end users. These shifts have been accompanied by complementary changes in trade execution methods. Market structure may be slowly shifting towards a more relationship-based form of trading, albeit in a variety of electronic forms.