Currency traders, beware -- markets are becoming more vulnerable to price spikes as trading volume falls, according to BNP Paribas SA.
“Due to the lack of liquidity, you could have severe market moves,” Robert McAdie, head of research and strategy at BNP, said in New York Wednesday. “That’s a phenomenon that’s here to stay for some time because of the liquidity and the way the market trading dynamics are shifting more towards electronic trading.”
Extreme price fluctuations in foreign exchange, bonds and equities are becoming more likely because as trading volumes drop across financial markets, McAdie said.
JPMorgan Chase & Co.’s Global FX Volatility Index, a measure of anticipated price swings, climbed to an average 10.4 percent this year, the highest annual average since 2011. That’s up from a record-low 5.28 percent in July.
“You have what are called these volatility spikes in the system that make it very difficult to manage risk and can lead to quite significant distortions,” McAdie said. “When something goes wrong, you’re going to have a whole lot of people trying to squeeze through a narrow door.”
Currencies fluctuated more this year as the U.S. Federal Reserve signaled it’s moving closer to raising interest rates, contrasting 30 other central banks that have eased policy.
On March 18, the euro rallied as much as 4.2 percent after the Fed indicated the pace of rate increases will be slower than it previously predicted. That was the biggest one-day gain since 2000, with the largest advance occurring at about 4 p.m. New York time, when trading is typically thin.
“It’s pretty clear that liquidity conditions are worse than they were a year ago,” Jens Nordvig, managing director of currency research at Nomura in New York, said by phone Wednesday. That’s reflected by widening bid-offer spreads and bigger price movements, he said, citing recent swings in the euro and Mexican peso.