It is apparent the foreign exchange market is starting to shrink at an alarming pace. Hedge funds and speculative investors no longer show much of an interest in the FX market, which is anything but positive news. Banks are taking fewer risks as well, resulting in a reduced trading on platforms. In a way, this is threatening future global financial stability, which may very well lead to the next recession.
FX Markets Are Not Appealing Enough Anymore
A new analysis performed by the Bank of International Settlements paints a very worrisome future for financial stability around the world. Regulators should, according to the study, be more concerned about the lack of support across FX markets, but they are focusing their attention elsewhere. Up until this point, the FX market represents US$5tn per day in volume, a number that has fallen sharply since the end of 2014.
Changes are driven by many different factors. First of all, banks are adapting their business models, so they run less risk when a volatile situation occurs. Additionally, there has been stricter regulation in the FX market, which makes it less appealing for traders and investors. Plus, the Swiss Franc has shaken up the foreign exchange markets beyond belief in early 2015, repercussions of which can still be felt to this very day.
Bank of International Settlement Head of Research Hyun Song Shin stated:
“Financial disruptions can have a real economic impact. How the evolving FX market affects risk-sharing is still uncertain, but this is a matter of first-order importance. Any major changes to liquidity conditions might have consequences for market risk and the effectiveness of the hedging strategies of corporates, asset managers and other foreign exchange end users.”
Rest assured those changes are coming, and the FX market will feel the brunt of the repercussions. It is the first time since 2001 the market contracted, which has many financial experts on edge right now. Speculative investors are hedging their bets and look for more favorable options outside of the FX market. Bitcoin has become one such valuable asset,t although only on a small scale for the time being.
We live in an era where market volatility is becoming a daily occurrence. Although this used to be a successful formula for big profits – or significant losses – traders and central banks are less keen to take the plunge. That is not entirely unexpected, as the law thing the financial sector needs right now is another recession. Or perhaps that is exactly what it needs, depending on whose side you are on.
Header image courtesy of Shutterstock
