Publication - Foreign exchange liquidity in the Americas
Introduction
In recent years, the issue of foreign exchange (FX) market liquidity has attracted a great deal of interest. By some conventional measures, specifically narrow bid-ask spreads, FX market liquidity appears abundant. And yet, some market participants have expressed concern about global FX market liquidity. Forces such as technological innovation and regulatory change are changing how the FX market operates
. In particular, major shifts in liquidity provision and market structure suggest that liquidity is ample in some segments of the global FX market, in part because of technology. However, liquidity in some ways appears to be harder or more costly to find in other FX segments, as reflected in the significant decline in the size of transactions that can be executed at the prevailing price, challenges posed by market fragmentation (eg locating suitable counterparties or ensuring best execution), and recurrent episodes of price volatility and illiquidity.
Central banks are concerned with liquidity in FX markets and related metrics for several reasons. Prolonged illiquidity in FX markets can undermine the effectiveness with which monetary policy is transmitted to the broader economy, particularly in cases where the central bank conducts operations directly in the FX market. It can also hamper cross-border investment and financing transactions or contribute to financial market instability, which can in turn adversely affect economic activity. In extreme cases, FX liquidity may vanish, which in the past has been associated with FX market closure and even balance of payments crises, particularly in emerging market economies. While advanced FX markets are traditionally robust, a lack of FX market liquidity has sometimes been observed, particularly during the Great Financial Crisis (GFC).
To assess FX market liquidity in the Americas, a study group was formed by the CCA Consultative Group of Directors of Operations,1 comprising BIS member central banks in the Americas region, to produce a report on FX market liquidity. The report draws on data from the BIS Triennial Central Bank Survey of foreign exchange and OTC derivatives markets in 2016 and other sources, central bank information, discussions with (private sector) market participants and some recent research.
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