We get a lot of questions in our daily work in foreign exchange. This week we’d like to pause for a moment to answer a couple of these questions that might help put FX in better perspective.
First, let’s start with a little context. The foreign exchange market is the largest financial market in the world. The Bank of International Settlements in Switzerland does an exhaustive triennial survey of the FX markets and the last time it was studied in 2013, the BIS calculated that $5.3 trillion per day is dealt in foreign exchange. This is up from $4.0 trillion in 2010 and $3.3 trillion in 2007.
Clients often ask us why it’s so turbulent. One of the reasons is that regulation is fairly minimal and the market is so massive in scope – with so many trades around the world during the work week, and so many economic events and large players influencing these trades.
In addition, the market is made up of some very diverse participants, each with different needs and goals. Most are in the market to make money from the fluctuating differences in rate, while another large group is simply trading currencies for personal or business reasons. Often these two groups are trying to figure out the behavior of the other, to try and preempt a currency move.
There is also a perception that if these markets just calmed down that FX rates would move to some equilibrium or would someday become fixed with each other again. That, of course, cannot happen as FX markets are now so intertwined with all other capital markets that are constantly moving. What would happen if exchange rates were fixed around the world? Would that help decrease the volatility of global markets? Not really. Market risks are seldom eliminated. They just shift from one market to another.
A prominent recent example can be seen in the U.S. dollar’s strength in the past few months due to expectations of rising U.S. interest rates. If the U.S. dollar did not absorb much of the pressure of global investors flocking to the U.S., the market would just react in the prices and yields of bonds.
My View: I understand how unpredictable and complex foreign exchange can be. It is a passion of mine, and everyone here on my City National team, to help clients understand what’s driving this market.
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