Tag: foreign exchange market

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The inexorable growth of FOREX

Every three years the Bank for International Settlements (the central bankers’ central bank) publishes a survey of foreign exchange market activity. The latest survey has just been published. Despite the banking crisis and subsequent recession, foreign exchange market turnover has increased by nearly 20% since 2007. The daily average value of currencies traded on the foreign exchange market is now $3.981 trillion. In 2007 it was $3.324 trillion and in 2001 it was just $1.239 trillion.

According to the BIS press release:

• The increase was driven by the 48% growth in turnover of spot transactions, which represent 37% of foreign exchange market turnover. Spot turnover rose to $1.5 trillion in April 2010 from $1.0 trillion in April 2007.

• The increase in turnover of other foreign exchange instruments was more modest at 7%, with average daily turnover of $2.5 trillion in April 2010. Turnover in outright forwards and currency swaps grew strongly. Turnover in foreign exchange swaps was flat relative to the previous survey, while trading in currency options decreased.

• As regards counterparties, the higher global foreign exchange market turnover is associated with the increased trading activity of “other financial institutions” – a category that includes non-reporting banks, hedge funds, pension funds, mutual funds, insurance companies and central banks, among others. Turnover by this category grew by 42%, increasing to $1.9 trillion in April 2010 from $1.3 trillion in April 2007. For the first time, activity of reporting dealers with other financial institutions surpassed inter-dealer transactions (i.e. transactions between reporting dealers).

• Foreign exchange market activity became more global, with cross-border transactions representing 65% of trading activity in April 2010, while local transactions account for 35%.

• The percentage share of the US dollar has continued its slow decline witnessed since the April 2001 survey, while the euro and the Japanese yen gained relative to April 2007. Among the 10 most actively traded currencies, the Australian and Canadian dollars both increased market share, while the pound sterling and the Swiss franc lost ground. The market share of emerging market currencies increased, with the biggest gains for the Turkish lira and the Korean won.

• The relative ranking of foreign exchange trading centres has changed slightly from the previous survey. Banks located in the United Kingdom accounted for 36.7%, against 34.6% in 2007, of all foreign exchange market turnover, followed by the United States (18%), Japan (6%), Singapore (5%), Switzerland (5%), Hong Kong SAR (5%) and Australia (4%).

The following articles look at some of the details of the report and consider their implications for London and for the global economy: an economy that has grown (in money terms) by 82% since 2001, while exports have grown by 101% and foreign currency transactions by 221%.

Articles
Giant FX market now $4 trillion gorilla Reuters (1/9/10)
Global currency trading jumps 20% in three years BBC News (1/9/10)
Daily foreign-exchange turnover hits $4 trillion Market Watch, William L. Watts (1/9/10)
Banks’ shift pushes FX trading to $4,000bn a day Financial Times, Peter Garnham and Jennifer Hughes (1/9/10)
Demonised ‘algos’ push the surge in FX trading Financial Times, Jennifer Hughes (1/9/10)
A valueless banking boom? BBC News Blogs: Peston’s Picks, Robert Peston (1/9/10)
Financial crisis boosts London’s dominance in global currency trading Telegraph (1/9/10)
BIS Triennial Survey of Foreign Exchange and Over-the-Counter Interest Rate Derivatives Markets in April 2010 – UK Data Bank of England News Release (1/9/10)

BIS documents
Press Release Bank for International Settlements (1/9/10)
Report “Triennial Central Bank Survey of Foreign Exchange and OTC Derivatives Market Activity in April 2010 – Preliminary global results – Turnover” Bank for International Settlements (1/9/10)
Statistical Tables Bank for International Settlements (1/9/10)
Link to previous reports Link from Bank of England site

Questions

  1. Why has the foreign exchange market grown so strongly (a) since 1998; (b) since 2007?
  2. How has the balance of the types of foreign exchange transactions changed since 2007? Explain why.
  3. What are the implications of this growth for the UK economy?
  4. What are the implications of this growth for the stability of exchange rates?
  5. What are ‘algos’ and what benefits (if any) do they bring to the foreign exchange market?
  6. What are the benefits and costs of the growth of foreign exchange carried out on behalf of financial (as opposed to non-financial) businesses?
  7. Where in a balance of payments account would the bulk of foreign exchange transactions be recorded?
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Dollar resurgence?

Until recently, gold prices had been rising. If you watch TV, you can hardly have failed to notice the adverts offering cash back for your gold. After peaking on the 2nd December 2009, however, at about $1220 an ounce, the price of gold fell almost $100 in just four trading days.

Over the past two months, we’ve seen a fluctuating US dollar and a fluctuating price of gold. In the news item ‘A golden age‘ we looked at the factors that led to a rising price of gold and one key factor was the weakness of the dollar. However, the dollar’s downward spiral appears to have halted, at least for the time being.

Figures for US GDP were higher than expected, with increases in economic activity in the 4th quarter of 2009. This may partly explain why the dollar strengthened, and prices of gold began to fall, as people began investing in US assets. And it was not just gold that fell – there was speculation that the price of copper too would fall as investors switched to US assets.

Then, at the end of January the dollar fell against most currencies and a variety of refined products recovered from recent losses incurred. This pause in the demand for the dollar may cause gold prices to increase once again, as traditionally, gold moves inversely to Greenback. Although the price of gold was down 1.1% for the month of January, speculation that the US budget deficit could be as big as $1.6 trillion could mean further support for gold and testing times to come for the dollar.

At the beginning of February 2010, the US dollar weakened against the euro, as investors favoured a return to riskier assets in search of higher returns, encouraged by signs of strengthening manufacturing in key economies. With the global economy coming out of the worst downturn in decades, will the dollar begin to strengthen?

Dollar advances on reduced demand for risk Wall Street Journal (15/1/10)
US dollar on defensive as risk appetite rises Business News (2/2/10)
US dollar on defensive as risk appetite rises Business News (2/2/10)
Why the price of gold is rising BBC News (13/10/09)
Gold trend remains firmly down despite dollar rally confronted by massive US budge deficit The Market Oracle (1/2/10)
Gold may rise for first time in week as dollar spurs demand The China Post (2/2/10)
Dollar and Yen fall as optimism returns Daily Forex Strategy Briefing, Hans Nilsson (2/2/10)
Gold declines for second day, as dollar’s advance curbs demand Bloomberg, Kim Kyoungwha (8/1/10)
Crude ends up as equities rise, dollar slips Reuters (25/1/10)
Copper may decline as stronger dollar saps demand Bloomberg (22/1/10)

Questions

  1. How is the price of gold determined? Use a diagram to illustrate this process. If there is a change in demand or supply for gold, what factors will affect the extent of the price change?
  2. Why does a strengthening dollar imply a lower price of gold?
  3. Why will a large US budget deficit support gold, but test the dollar?
  4. How is the exchange rate determined? What factors affect the supply of dollars and the demand for dollars?
  5. What are the main factors that could explain why there has been a rise in the dollar? Could speculation play a role?
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Tobin’s nice little earner

Commentators and policy makers are casting far and wide to try to find policies that may offer solutions to the banking crisis and the financial situation it has caused. One proposal (considered in two articles below) is the introduction of a Tobin tax. A Tobin tax is a levy on currency transactions and the argument is that this will act as a disincentive for short-term speculation and therefore force traders in financial and currency markets to look more at medium- to long-term rather than short-term gain.

Tobin’s nice little earner Guardian (15/10/08)
Make state capitalism pay its way Guardian (26/9/08)

Questions

1. Explain what is meant by a Tobin tax.
2. Assess the arguments for and against the imposition of a Tobin tax on currency transactions.
3. Discuss whether changes to the regulatory structure of currency markets may be more effective than the introduction of a Tobin tax.
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Britain – the land of the $5 ice cream?

The fall in the dollar has continued with the value of sterling rising above $2.10 for the first time in 26 years. The articles below look at a range of issues related to the strong pound and there are also case studies of the impact on a guitar strings company and the manufacturer JCB.

Questions

1. Identify the main factors that have caused the fall in the value of the dollar. Use supply and demand to illustrate your answer as appropriate.
2. Assess the impact of the strong pound on UK exporters and importers.
3. Discuss whether intervention in the foreign exchange market may be appropriate to help UK exporters to remain more competitive in world markets.