Emerging Market FX Trading: Liquidity Challenges

Terry Flanagan

When trading emerging market currencies, the ability to extract pertinent information is extremely important, as liquidity in these currencies is usually much thinner than for the G10 currencies.

“The depth of the market in EM is not what it is in G10,” Chris Maxmin, head trader at Moon Capital, which manages about $1.5 billion, told Markets Media. “Sometimes the relationship is more important than the electronics. Liquidity not being there in a lot of these markets is why relationships are important. It’s good that you’re seeing more electronic trading, but some parts of the market are a crap shoot. You may get best execution on part of your order but not all of your order.”

Even within the G10 currencies, outside of euro and yen, information on liquidity may be lacking. “When you look at these markets that should be spot on in G10, they’re a little off,” said Maxmin. “Then extrapolate that to emerging markets. You can do euro, pound, yen all day long, but if somebody tries to put on a big emerging markets trade without any news, you will see a big move in Turkey or a big move in Iran.”

The renminbi (RMB), meanwhile, continues to grow as an international currency. United States’ RMB payments value increased by 327% between April 2013 and April 2014, placing the United States third in the world for RMB payments value, excluding China and Hong Kong, according to Swift’s RMB Tracker.

RMB payments value in the United States to China/Hong Kong corridor grew 229% between April 2013 and April 2014 and accounted for 2.4% of all payments value as of April 30, 2014.

“The growing adoption of RMB payments in the United States to China/Hong Kong corridor is a significant milestone that further promotes the cross border use of the currency,” said Michael Moon, head of payments, Asia Pacific at Swift, in a statement.

Although the corridor remains dominated by the US dollar, data suggests that the United States is increasingly using the RMB to support its corporates that want to reach more suppliers in mainland China. “This is good news for the internationalization of the RMB as a world payments currency,” Moon said.

In general, the G10 currencies move slowly against one another unless there’s an economic event or some big news, such as the announcement by the European Central Bank that it’s cutting interest rates to negative 0.1%. The move has generated talk about a potential European version of the U.S. Federal Reserve’s quantitative easing.

“The ECB is incapable of boosting demand and this is especially true with the demanded reforms, a too high currency for most of Europe, and austerity budgets combine to suppress rather than support current demand,” said Steve Blitz, chief economist at agency broker ITG. “It was funny how [Draghi] does not see a deflation risk because he doesn’t see households delaying consumption plans. With euro-zone unemployment near 12% and 25% in Spain, households have no consumption plans.”

Essentially what the ECB initiatives do is transfer funds from bank balance sheets to nonfinancial balance sheets. “It does nothing to guarantee or ensure the capital borrowed essentially for free by nonfinancial firms is spent on expanding productive capacity or boosting inventories,” said Blitz. “Borrowing to spend requires a presumption, on the part of NFCs, of greater future demand for their product.”

Featured image via iStock

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