Another Liquidity Pool Drying Up

November 13th, 2015 7:34 am | by John Jansen |

I have published numerous articles here on the evaporation of liquidity in both the corporate bond market and the Treasury market. Add a new giant market to that list as Bloomberg reports this morning on the impairment of liquidity on the Brobdingnagian FX market.

Via Bloomberg:
Candice Zachariahs
Anchalee Worrachate
Lananh Nguyen
November 12, 2015 — 6:03 PM EST
Updated on November 13, 2015 — 6:18 AM EST

From kiwi to krone, spread between bids and asks is widening
`Erratic and volatile’ becoming the norm even in G-10


Even the world’s biggest financial market can’t escape the global liquidity drought.

Currency traders accustomed to shifting billions of dollars around the globe are starting to suffer as dealers retrench. Investors facing higher costs in this environment could rein them in with strategies that include splitting trades into several tranches, timing transactions to match peak turnover and avoiding a change of position too close to big events, according to money managers at Pioneer Investments and Macro Currency Group.

We’re not talking about emerging markets here.

From the Australian and New Zealand dollars to the currencies of Norway, Sweden and Switzerland, the gap between the price quoted for sales and for purchases is widening, data compiled by Bloomberg show. Those five represent 19 percent of daily average foreign-exchange volumes. For the kiwi and krone, the mean spreads are at levels unseen since the 2008 global credit crunch.

“The markets are significantly less liquid now than they were before the financial crisis,” said Mark Farrington, the London-based managing partner at Macro Currency Group, which oversees more than $7.7 billion. “Where we had a very fluid, deep, liquid 24-hour market in 2007, you have now pockets of liquidity in the FX market based on the depth and strength of the market makers that are specialists in those currencies.”
Bank Regulation

As regulation pushes banks to reduce their market-making activities, liquidity — the ability to trade without having prices move against you — is becoming more patchy. That’s leading to undependable pricing during times of stress and belying the 24-hour nature of the currency market.

New Zealand’s dollar fell 3 U.S. cents over 10 minutes in late August, before rebounding. The kiwi’s average daily range since 2000 is less than a cent. This Wednesday, the nation’s central bank blamed the incident on diminished liquidity. The same culprit was named in an investigation into unusual movements in the Aussie dollar prior to central bank decisions.
The kiwi’s August crash saw a dramatic gap between prices sought by buyers and those sellers were willing to take

The Norwegian krone weakened 2.1 percent versus the dollar to a 13-year low on Sept. 24 when the central bank surprised the market by cutting interest rates to a record. It has tumbled by more than 2 percent on four occasions this year, versus none in 2014. Foreign-exchange analysts have also decried surprisingly big moves in Sweden’s krona.

“The market is more erratic and volatile,” said Andreas Koenig, the Dublin-based head of European foreign-exchange at Pioneer Investments, which oversees $242 billion. “While you can do and trade whatever you need to, the spreads get wider. The cost of liquidity is higher.”

Australia’s dollar is the world’s fifth most-traded currency with a daily average turnover of $462 billion in April 2013, according to data from the Bank for International Settlements. That’s almost double Apple Inc.’s annual revenue from selling iPhones, iPads and other gadgets. The franc is next, while the kiwi and krona are in 10th and 11th place and the krone is number 14. Together, they account for $1 trillion of the $5.3 trillion over-the-counter transactions in currency markets.

Not everyone says the widening in spreads is a problem.

“Things were over-liquefied” as recently as two years ago because banks were competing for business, said Peter Gorra, head of foreign-exchange trading in New York at BNP Paribas SA. “We’re finally seeing the more natural liquidity in the market for what it is, as opposed to banks always going ahead of themselves trying to win as much market share. People are used to it now.”

The top tier of currencies — the euro, yen and pound — have so far remained broadly unaffected, though even they had a blip during turbulent trading in August. Those three account for 78 percent of all trades against the U.S. dollar, which is the world’s reserve currency.

The widening in spreads began at the end of 2014 as speculation intensified that the European Central bank would move to start buying bonds. It then accelerated after the Swiss National Bank surprised traders with a decision to abandon its cap on the franc against the euro. Price quotes moved apart again in the run-up to the Fed’s September interest-rate decision, when some economists were predicting an increase in the benchmark rate.

The most dramatic moves have been in the Norwegian krone and New Zealand dollar, which are also the worst-performing G-10 currencies this year with losses of 14 percent and 16 percent, respectively. The krone was at 8.66 to the U.S. dollar as of 6:15 a.m. in New York while the kiwi fetched 65.36 U.S. cents.
‘Bad Friend’

“The level of bid-offer spreads is similar to what it was during the Taper Tantrum” in mid-2013, when the Fed suggested it may start to reduce stimulus, said John Normand, head of foreign exchange, commodities and international rates research at JPMorgan Chase & Co. in London. “That suggests it’s quite challenging.”

While dislocations may provide opportunities for investors, they also bring challenges, according to London-based Luke Bartholomew, an investment manager at Aberdeen Asset Management Plc, which manages $483.3 billion.

“The real worry about liquidity is that it behaves like a bad friend — it is there when you don’t especially need it, but as soon as you do need it, it disappears.”

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