Why FX Markets Are Key in Measuring Global Risk

Financial markets were surprised recently when European Central Bank (ECB) president Mario Draghi announced a cut to all of the ECB’s benchmark rates, most notably the deposit rate was cut 10 basis points from -0.3 to -0.4 percent as well as adding an additional €20 billion of quantitative easing bringing the total to €80 billion on a monthly basis. The ECB also expanded asset purchases to high-quality corporate bonds, which is a marked change from previous operations.

In addition, Draghi announced a new loan program that will last four years aimed at allowing banks to be compensated for taking in ECB money if they expand credit and lending to companies in the Eurozone.

Most of these moves were unexpected, and all  were reflected in foreign exchange (FX) futures markets. On the day of Draghi’s announcement (March 10), more CME Group foreign exchange contracts were traded than on any day in the market’s 44-year history. A total of 2,517,334 futures and options contracts traded, beating the previous record – set May 6, 2010 – by more than 146,000.

Naturally, a high percentage of trading was in Euro futures and options, which traded a notional value of €113.5 billion.  However, the record volume can’t be entirely attributed to the ECB’s actions as it occurred during the futures roll period, which typically attracts more trading volume.

2016 has proven to be a strong year for FX trading overall. Japanese Yen average daily volume is up 38 percent over a year ago, for example. Trading in that currency comes largely from market participants seeking a safe haven currency during times of volatility.

As volatility in energy and metals markets has increased, it has led to more trading in emerging market and “commodity” currencies – those in countries where commodity exports are a major economic driver. These currencies include:

  • Australian Dollar +21 percent
  • Canadian Dollar +32 percent
  • Brazilian Real +23 percent
  • Mexican Peso +35 percent
  • Indian Rupee +11 percent

All of this is a reminder of how foreign exchange corresponds with other markets, and serves as a risk mitigation tool when some assets prove less predictable. As central banks continue to use new policy tools, and commodities continue to seek price stability, the trading activity we’re seeing in FX markets will continue warrant close watch.

Craig LeVeille is executive director of FX Products at CME Group.

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