Currencies thatare traded

Another unchanging aspect of the FX markets is the dominance of the U.S. dollar (USD), which is still involved on one side of roughly three-quarters of all spot transactions (Table 3). The dollar’s dominance reflects the market’s practice of trading minor currencies via a major currency (called the vehicle currency). A trade from Mexican pesos (MXP) to Australian dollars (AUD), for example, would typically involve two trades, one from MXP to USD and a second from USD to AUD. This “vehicle” trading through the major crosses concentrates liquidity in a narrower range of currency pairs, reducing overall transaction costs. The euro (EUR) is involved in 46 percent of trades, in part because it serves as the vehicle currency within the eurozone.

The next most actively traded currencies are the Japanese yen (JPY, 20 percent) and the UK pound (GBP, 14 percent). Together, these four currencies are known as “the majors” (or G4)

Table 3: Currency distribution of spot turnover (%)

The next tier below the majors comprises the Australian dollar (AUD, 7.5 percent), the Swiss franc (CHF, 6.2 percent), and the Canadian dollar (CAD, 5.2 percent). A notable recent shift is the rising share of the so-called commodity currencies, specifically the AUD, CAD, the Norwegian krone (NOK), and the New Zealand dollar (NZD). These currencies’ combined share rose from 7 percent in 1998 to 16 percent in 2010.

The share of emerging-market currencies rose sharply in the 1990s but has been fairly stable around 18 percent since then. Nonetheless, currencies from the most advanced emerging markets, such as the South Korean won (KRW) and Hong Kong dollar (HKD), have more than doubled their market share since 1998 and now rival the Swedish krona (SEK). Turnover in more recently emerging countries, such as Turkey, Thailand, Brazil, and India, has grown even faster.

The conventions governing the quotation of different currency pairs have also been fairly stable over time. Most exchange rates are expressed as units of a given currency required to purchase one US dollar.

The exceptions are the EUR, the GBP, the AUD and the NZD, which are quoted as the base currency (i.e. EUR/USD = USD per EUR). Most exchange rates are quoted to five significant digits, with the final (or smallest) digit known as a “pip”.

Instruments thatare traded

The dominance of spot FX trading is another area of relative stability. Daily spot turnover in 2010 was $1.5 trillion while turnover in outright forwards was far lower, at $0.5 trillion (BIS, 2010). A number of other currency-related instruments – FX futures, currency options, FX swaps and currency swaps – swell average daily turnover in FX markets beyond $4.0 trillion (Table 4).

These assets are traded entirely separately from spot and forward contracts and for entirely different purposes, so they generally have little influence on exchange rates.

Table 4: Instruments traded in global FX markets

FX swaps deserve some discussion, however, because of their immense average daily turnover of $1.8 trillion. Like repos in the fixed income markets, FX swaps are used primarily for overnight position management by banks. Collapsing swap volumes following the Lehman Brothers bankruptcy in late 2008 triggered a rapid expansion of central bank swap activity as authorities tried to stabilize the world banking system (Baba and Packer, 2009; Melvin and Taylor, 2009). In 2010, FX swap trading activity remained below its previous peak.

Date: 2014-12-28; view: 1163