FX in 2024: A Strong Pass

With only a couple of weeks to go until the end of 2024 it feels like an opportune time for Eva Szalay to provide a quick appraisal of the FX industry’s performance in the past 12 months and the short version is positive.

FX markets passed 2024 with flying colours. First things first, money. Revenues at large dealers are up with foreign exchange receiving a special mention in the third-quarter at Deutsche Bank, JP Morgan and UBS among others, as drivers of growth and profitability. The Fed’s rate cuts and the US Presidential election both brought with them plentiful opportunities to benefit from market moves, which have clearly been taken.

Secondly, nothing broke, despite continually growing volumes and higher volatility than in the majority of the past decade. There was also the small matter of North American equity markets transitioning to T+1 settlement, which dramatically shortened the time available for FX desks outside the US to hedge and process trades.

The transition at the end of May caused much anxiety in the run-up to the deadline, but the event itself went off without a glitch, and with the Bank of England’s FX Joint Standing Committee stating in September that “no significant issues continue to be observed following the transition”, there has been no negative knock-on effect.

Possibly the most notable episode of the year that was centred on FX itself was the Japanese yen carry trade “blow-up” that was unleashed in August and caused serious ructions in other markets. The FX market, however, remained well-functioning and the few days of high volatility proved to be a boon for trading volumes, and while it may have been painful for some, anyone who wanted a price to exit their position, found one.

Flash crashes were mercifully absent this year, aside from few lively moments around the yen in April and the roughly 7% wobble in the Mexican peso the same month, but as The Full FX contributor Stephen Flanagan is fond of pointing out, the markets tended to trade at every price point. This means liquidity conditions were generally fine, and they stayed that way despite the ongoing flare-ups in geopolitical tensions, a record number of national elections, including the US, and changes in central bank policy rates.

The resilience of FX market liquidity was a partial focus of a late November working paper from the BIS, dubbed Through stormy seas: how fragile is liquidity across asset classes and

Time?, which examined what happens to trading conditions during periods of stress using 25 years’ worth of high-frequency data across equities, FX and bond markets in the US and Europe.

The paper found that the average bid-ask spread has declined across all asset classes over the past 25 years, noting that while the absolute and relative magnitude of the decline changes across asset classes and regions, “the overall decline is notable.”

FX stands out, however, with the authors finding that the decline in average spreads has come at a cost in equities and government bonds, where there has been a corresponding increase in the number and frequency of episodes where markets become illiquid. “In contrast, the FX market does not display this increased fragility,” the paper stated.

The Long-Term Impact of Speed Bumps

Given FX did handle 2024 so well, and historical has done so better than most other asset classes, what is driving that ability to thrive in the toughest conditions? The paper cites the unique nature of automation in currencies markets, specifically two factors: the rapid introduction of latency floors in response to aggressive algorithmic strategies such as latency arbitrage, and the subsequently stabilising ratio of bank and non-bank algorithms.

A separate BIS paper last year showed that while algorithmic trading dominates in FX markets since 2022, the share of bank API and non-bank API activity remained stable at 40% each from 2015 onwards. This matters because both papers differentiate between the two types of algorithmic trading the same way, with non-bank APIs automating both the decision and the execution of the trade, while bank algos tend to rely on humans taking the initial decision and only the execution is automated.

“FX markets have adapted swiftly to mitigate the impact of HFT activities through measures such as “speed bumps” introduced by major players and trading venues in 2013-2014. These measures have reduced the influence of non-bank APIs, making FX markets less susceptible to aggressive HFT activities compared to equity markets, which could be related to the skewness of the bid-ask,” the authors write.

Issues Remain for 2025

Whilst the market has fared well in the past 12 months, there are still kinks to iron out, however. Settlement risk remains a major focus area as risks have been building for years now, regulators think. The updated FX Global Code, due to be published before the year is out with three settlement-focused changes expected, according to the BoE’s FXJSC.

These include strengthening Principle 35 by the addition of a risk waterfall approach for managing FX settlement risk, updates to Principle 50 to make it clearer how market participants should measure, monitor and control FX settlement risk and proposed changes to Principle 51 aiming to discourage the use of multiple settlement instructions for the same counterparty.

FX data also remains on the slate for 2025 and regulatory developments continue to rumble on with the platform perimeter question in the UK and the EU as well as DORA kicking-in.

Finally, of course, there is the unknown – it seems unlikely the geopolitical environment will calm down – and while the FX market is very good at handling “known-unknowns”, there are still risks from the “unknown-unknowns”.

That is looking forward, but for 2024, the assessment is no caps slay, as Colin would say.