FX Volatility “Trumping” Forward into 2017

By Ivy Schmerken, Editorial Director

The unanticipated election of Donald Trump to the U.S. presidency has boosted trading volume and volatility in currencies, and many see an opportunity to generate profits that has eluded them for several years.

Eight days after the U.S. presidential election, market participants gathered at a Markets Media FX-Trading 2016 event in New York City to assess the impact of a Trump administration on the FX market ecosystem. Talk rapidly turned to the possible effect of Trump’s policies on volatility in currency markets as well as major regulations like the Dodd Frank Act and the role of trading algorithms.

Citing president-elect Trump’s previous comments on renegotiating trade deals with Mexico, scrapping NAFTA, and accusing the Chinese government of currency manipulation, panelists agreed there’s a lot of volatility and volume spikes ahead.

In the first week after Trump’s victory, the dollar soared 2.4% against a basket of 16 currencies, the largest weekly gain since May of 2015, reported The Wall Street Journal.  By Dec. 8, the U.S. currency had strengthened 4.3% since the Nov. 8 election, reaching a 14-year high, according to the WSJ in “Strong Dollar Disrupts Firms.”

So far, the unexpected Trump victory has resulted in a surging US dollar, volatile trading and huge price swings in rival currency pairs like the Euro/USD, Euro/GBP and Mexican Peso/USD.

“In our networks, we’ve seen big flows coming through,” said Bruce Wolf, Head of Sales, Americas Region, EBS BrokerTec who spoke on the FX panel.

A rise in foreign exchange volumes tends to be positive news for banks and brokerages that are active in the $5 trillion a day market.

“Trading volumes in the dollar and a handful of major currencies surged to up to 10 times annual averages as the first signs of Donald Trump’s victory in US presidential elections emerged on Wednesday,” reported Reuters on Nov. 8. Separately, CLS, which settles more than 90 percent of all trades in the global currency market, announced that volumes in the Mexican peso, which are normally lower during Asian trading houses, jumped to 63 times the average, reported Reuters

With increased volatility, people find opportunities for trading, said a speaker at the FX event. But there is uncertainty because what happens depends on what Trump implements after he is sworn in, said several FX panelists.

Currency moves could benefit hedge funds and proprietary trading shops, which seek to exploit market inefficiencies. But will the volatility continue into 2017?

• Many FX executives expect to see more volatility especially in energy markets and currencies.  A similar finding came from a survey of the TabbForum community, released on Dec. 2^nd. The community’s members expect energy, equities, metals and the US dollar would outperform credit and rates. The survey also predicted an increase in volatility, and a relaxation of financial regulations.
• Algorithmic trading will continue to be a factor in FX markets. However in 2017, there will be a geopolitical component to algos, as compared with standard economic number crunching. Look for proprietary trading shops to be more macro-event driven in their trading. “Different shops provide different types of algos,” said one panelist. Investment managers also might trade with an algo to express a macro view.

 Two Shocks: the US Election and Brexit

Several FX professionals at the Markets Media event drew comparisons between the US Presidential election and the shock of UK’s Brexit vote on June 24.

While currency markets reacted with volatility after the UK’s Brexit vote to leave the European Union, trading has returned to normal, noted one panelist. However, the Trump effect is different because there’s a lot of uncertainty on what’s going to happen, said a panelist, who pointed to volatility and higher volumes beyond the first week.

As a sign of the volatility, moderator Henrique Hablitschek, senior business development manager at Equinix, noted that the Mexican Peso-USD rate had fallen by as much as 13% on the day after the U.S. election, the lowest level since the so-called Tequila Effect, an economic crisis in 1994 when a sudden devaluation of the Peso impacted the South American economy.

With President-elect Trump targeting NAFTA, that is also injecting uncertainty in the dollar-Peso relationship. “There are about 5 million jobs in the U.S. related to trading with Mexico. You can’t just rip it up,” said one panelist.  Yet, “A lot has been built into pricing which is why the Mexican peso has crumpled so far,” said one speaker.

However, BrokerTec’s Wolf noted the peso has held, and that a lot of the movement is driven by interest rates being different between the U.S. and Mexico.

One of the big questions is whether Trump plans to tear up Dodd Frank or eliminate the Volcker Rule, which have raised capital requirements on market makers and reduced their capacity to warehouse OTC instruments, particularly bonds. Many blame the Volcker Rule for reducing liquidity in corporate bonds. “Unless you are a top-10 bank no one is taking principal risk anymore,” remarked an FX trading executive.

For banks, however, a lot of money has been built into compliance and regulation, noted FX professionals at the Markets Media event. Panelists suggested that if Trump is able to repeal Dodd Frank, they could see bank stocks doing well. If volatility curves upward, then high-frequency trading firms could also see their profits rise.

Though Trump has also said he would bring back the Glass Steagall Act to separate commercial banks from investment banks, one participant expressed doubt, comparing that to “putting the genie back in the bottle.”

Post-Election Volatility on Tap

With political uncertainty and global risks ahead, there is speculation on what policies the Trump administration will be able to implement.

Trump’s plans to boost infrastructure spending, cut taxes and loosen regulations have provoked a rally in bank stocks and a sell-off in bonds.

Higher volumes and volatility will help generate trading profits for Wall Street firms, perhaps increasing demand for algorithms, market data and electronic trading networks.

But some FX attendees at the Markets Media FX event were worried about the repeat of a flash crash in the British pound in Asia, which plunged 6% in a matter of minutes on Oct. 6 during Asian trading. There are concerns whether the FX spot market can absorb these types of shocks, given that banks are not able to commit risk capital to warehouse currencies.

Amid these headwinds, hedge funds are said to be increasing their global macro bets. “The markets have become a trader’s dream, ” reported the WSJ in “Traders Salivate as Volatility Increase.” One fund manager set up a new hedge fund to profit from “extreme events.”

Some hedge funds made profits from betting against currencies, including the yen, after the election, according to the article. A stronger dollar has led the Japanese Yen to plummet more than 8%.

It remains to be seen whether hedge fund managers will risk their profits to make additional bets on macro-economic trends, said the WSJ. Whatever happens, the new administration has brought change, along with risk and opportunity.

Past Blog Posts Related to FX Trading Issues:

FX Algo Usage Rises as the Buy Side Takes Charge

TCA: Bridging the Gap Between Equities and FX

A Hard Look at Last Look in Foreign Exchange

Best Execution FX: A Shifting Landscape

FX Liquidity and Technology — An Ecosystem in Flux

Buy-Side FX Shifts in Evolving Market Structure

Seven Trends the Buy-Side Needs to Consider