Positive Indicators & Market Volatility Accelerate Auto-Trading

Early trading data suggest institutional FX platforms have opened this year in better shape than they closed in 2022. Cboe’s institutional spot FX platform reported a 17% increase in total trading volume in January compared to the previous month, while Euronext’s trading volumes were up by 9.5% over the same period. It was a similar story at FXSpotStream and 360T where average daily volumes were up month-on-month by 5.2% and 13.9%, respectively.

While some of this increase can be attributed to lower trading activity in December as a consequence of the Christmas and new year holidays, it is also a reflection of positive indicators including more encouraging global economic data and continued market volatility on the back of interest rate policies.

A number of market participants agree that the most notable trend in the institutional FX trading space currently is the continued adoption of algorithmic trading.

“Over the past couple of years – and largely as a result of the coronavirus pandemic – uptake of FX algos has increased dramatically with clients and dealers looking to offset risk, access fragmented liquidity, and improve operational risk when working from home,” explained John McGrath, the Chief Revenue Officer at BidFX.

This growth has been further accelerated by the commoditised nature of FX trading, which lends itself particularly well to the rapid and widespread adoption of algos.

McGrath estimated that FX algo trading now represents as much as 20% of daily spot volume and said that this number is only going to increase as buy-side firms become more comfortable and reap the benefits of using the technology.

“Another notable trend is volatility, which goes hand in hand with the growing trend toward algos,” he added. “The return of volatility in the FX markets last year – driven by factors such as unpredictable fiscal policy from the UK government – has meant that algos will evolve yet again to become even more sophisticated.”

The impact of volatility is reflected across an institutional client base that in 2022 was preoccupied with regulatory changes and workflow efficiencies but is now more interested in liquidity availability and data management.

According to McGrath, while the impact of the pandemic continues to wane, the inflation hangover continues to affect institutional FX trades.

“Central banks began raising interest rates in 2022 to ease inflationary pressures, and it is likely that this will continue as many are expected to raise interest rates to their highest level in 15 years,” he said. “FX traders will be forced to adjust their strategy this year as risk factors that haven’t been relevant for a number of years come to the fore once again.”

The low-interest rate environment over the past decade has limited the scope for big carry trades based on interest rates or growth differentials. In this context, volatility presents opportunities and has provided a much-needed lifeline for institutional FX traders.

McGrath noted that interest in the bilateral clearing of non-deliverable forwards (NDFs) has been on the rise as institutional asset managers look to reduce the amount of margin they need to post under uncleared margin rules.

“FX is, after all, a by-product for the real money asset management community,” he said. “As opposed to trading currency markets for alpha, the vast majority of money managers are looking to manage risk around their currency exposures.”