The Last Look…

Here’s a question: Should EUR/USD be ring-fenced from the rest of the spot FX market?

This question, or rather a statement that it should, was put to me in conversation last week by someone in e-trading who declared the market “the most boring in the world”.

While the one-month US Treasury Bill market says “hold my beer”, I will explain that my conversant was bemoaning the time and resources spent on trying to win business, and maintain a presence in, a market that offers up “next-to-no-reward” – I suspect it had been a boring few days.

There is a fair bit of noise about the low level of volatility in FX markets at the moment, but things are happening in parts, not least EM, the yen, and even Sterling and Aussie. It may not be kicking off the way some of a certain generation would like, but there are moves offering opportunity.

I also think that even that “certain generation” (that would be mine in case you haven’t been paying attention and worked it out) needs to understand that this is the new reality. E-trading has, without doubt, dampened volatility, because, frankly, the machines are not willing to take a punt, and they are dominating spot FX trading.

Going back to the euro, and to reinforce this point, I have broken the pair’s extended history (using USD/DEM – look it up kids – as a proxy), into three distinct periods and looked at the ranges therein. Over the last 15 years, the range has, broadly, been 1.47-48 to 0.95-96 – plenty to get one’s teeth into there.

It pales into insignificance, however, when compared with the first decade or so of the euro’s existence, however, when the range was 1.60 to 0.8290. Obviously, and without getting all “economist” on you, this includes the period of growing pains – otherwise known as, to put it politely, “the period in which we all realised the criteria leading up to the euro was politically-based, and not economically”.

Interestingly, as someone who used to sit there and regularly watch yet another dollar-mark trader pull their hair out, and age disproportionately, in the 20 years before the euro, using the aforementioned proxy, the range was around 1.45-46 to 0.56-57 – only 11 big figures more.

Why do I pick these periods? Well, the last one takes in the Plaza and Louvre Accords period, when the dollar hit extremes and are largely for context, the middle one is very much about the early days of the euro, and the first one? Well, that’s very much about the growing domination of e-trading and the subsequent dampening of volatility – but is it?

I would argue it is more about zero interest rates around the world than e-trading, and if I look at the world now, I would suggest the direction of interest rates in different jurisdictions is getting more uncertain. Yes, there is an upward trend, but not everywhere.

For me, the number one problem in EUR/USD, and this highlights the influence of e-trading, is the sheer weight of data, which is providing a self-fulfilling doom spiral in interest. E-trading loves data, trades create data, there is more data in EUR/USD that anyone could possibly need, this in turn attracts more market makers or LPs (even though most are “churn and burn” merchants), which reinforces the amount of data – and the spiral.

I can absolutely see why my friend is fed up with EUR/USD, but this has probably been an issue for some time in this pair – it is also, as a minor diversion, why no European banks (ex-Deutsche) have dominated in FX over the past two decades, they simply have no “calling card” or differentiator. Their inventory has no value in the wider market.

So, to my friend’s actual suggestion – that we create, or select, one venue, which everyone connects to and trades just EUR/USD. Automate it, pop the risk into the market and watch it get eaten up by the machine. A single, true all-to-all, CLOB-type venue, that does boatloads of business meaning everyone can just press “go” and then ignore it and focus on more interesting stuff.

When I suggested to my friend that no platform would give up their EUR volume easily, they returned with the idea that the “super-platform” would be, effectively an “aggregator of aggregators” so they can keep the client and just auto-feed the business through. I am not sure who is swallowing the extra cost of that, but perhaps the better execution would cover it? Except would it be better execution?

You can argue that on a “super-platform” EUR 200 million trades will become a norm, and stop having an impact, but I doubt it when so many participants are surviving on repeated half-pip “turns”

I have three reasons why our (light-hearted, I should stress) conversation about ring-fencing EUR/USD will not work. The first is that we have no idea what is around the corner, and if the market does kick off, and we have serious volatility or a major directional move, then a lot of the so-called LPs will disappear, reducing data and so on. Even over the past five years, there has been a near 25 big figure range in the pair, so things are happening (perhaps people need to stop thinking about the next millisecond and take some risk on?), so it is not out of the question.

The second reason harks back to the question of better execution – the fact is there are countless data-driven “LPs” who shift the market, albeit only by a few micro-pips, based upon what they see in the order book. If this was going to work as an idea, EBS would probably be doing 750 yards a day now, given its dominant position in 2010-12. One of the reasons it isn’t (and here I also mention the loss of internalisation and proxy-hedging benefits) is because too many “LPs” were reacting to the order book, meaning anyone wanting to trade a serious amount was put off by the signalling impact.

Of course, you can argue that on a “super-platform” EUR 200 million trades will become a norm, and stop having an impact, but I doubt it when so many participants are surviving on repeated half-pip “turns”.

So, take EUR/USD out of the equation? It’s a tempting idea for many I am sure, but the reality is, unless the “super-platform” is totally dark, I don’t see how it works. Better to make sure your framework just works in the current form; not judge your business on dollars (or euros) traded, but on actual profitability; and not worry if you trade in the pair and it slips half a pip. The bottom line is it is something that can probably just run in the background.

The third reason is who pushes the market to this stage? It won’t be regulators, I doubt it will be clients and it definitely won’t be the platforms. It also won’t be banks because of the internalisation benefits and it won’t be The Full FX, because, frankly (and I did tell my friend this), I only really indulged in the conversation because it was Mrs L’s turn to pick the evening’s viewing and I hate Sci-Fi…

colin@thefullfx.com