Foreign-Exchange Turnover Dropped 'Sharply' in 2008, BIS Says
By Kim-Mai Cutler
March 2 (Bloomberg) -- Trading in the world's three leading currency pairs fell by about 50 percent on electronic-broking services in the last quarter as volatility climbed to a record, the Bank for International Settlements said.
"Activity levels dropped sharply across the board," Paola Gallardo and Alexandra Heath, analysts at the Basel, Switzerland-based BIS, wrote in a report released yesterday. "Market makers may have been less willing to quote on electronic platforms to avoid being caught by adverse price movements, thereby driving activity through phone transactions."
Currency fluctuations became more exaggerated after Lehman Brothers Holdings Inc.'s Sept. 15 bankruptcy drove investors to sell riskier assets and repay loans. Volatility implied by dollar-yen options expiring in one month, a measure of expectations for future currency moves, rose to 41.79 percent on Oct. 24, the highest level since Bloomberg began compiling the data in December 1995.
Increased volatility can deter traders by making profits more difficult to predict. Firms that rely on electronic transactions, such as proprietary and prime brokerage accounts, may have scaled back foreign-exchange trading in line with other asset classes, the BIS said. Quantitative trading may have fallen as computer-based models failed to capture the changing market environment, according to the bank.
"Some forms of trading activity, such as automated trading, which rely on electronic execution methods and are based on rules designed to work in normal conditions, may be abandoned at times of high volatility," the bank said.
Money-Market Squeeze
The BIS said bid-ask spreads, or the difference between the best buying and selling prices, more than doubled between September and December as turnover fell. Euro-dollar is the most actively traded currency pair, followed by dollar-yen and pound- dollar, the BIS said in its triennial survey published in 2007.
As currency trading volumes slumped, short-term dollar funding needs for banks outside the U.S. became "acute" as financial institutions hoarded cash, freezing money markets, in the wake of Lehman's bankruptcy, BIS analysts Patrick McGuire and Goetz von Peter wrote in a separate study released yesterday.
Before the credit crisis erupted in August 2007, financial institutions accumulated positions in foreign-denominated assets that led to a short-term dollar funding gap for major European banks of between $1.1 trillion and $1.3 trillion, the report said. Institutions met their funding needs by borrowing from central banks and money markets, the BIS said.
The cost of three-month dollar loans rose to 332 basis points more than the Federal Reserve's target rate on Oct. 10, the biggest difference since at least 1984, as short-term funding markets dried up.
"The crisis has shown how unstable banks' sources of funding can become," the BIS said. "When heightened credit risk concerns crippled these sources of short-term funding, the chronic U.S. dollar funding needs become acute."
To contact the reporter on this story: Kim-Mai Cutler in London at kcutler@bloomberg.net
Last Updated: March 1, 2009 16:07 EST
