Dollar upheaval sparks FX trading boom
Banks’ foreign exchange trading desks are off to their best start to a year since 2022 after a sharp reversal in the US dollar ignited market volatility and triggered a surge in client activity.
The largest global banks’ FX revenues rose at an annual rate of more than 15% in the first quarter to more than US$6.5bn, according to data provider Coalition Greenwich. That haul represents one of the best quarters for FX trading in the past five years, only surpassed by the high-volatility periods surrounding the outbreak of the pandemic in 2020 and the Russia-Ukraine war in 2022.
Traders say activity accelerated at the start of the second quarter after US president Donald Trump on April 2 announced sweeping tariffs. Concerns over Washington’s policies and a slowing US economy have since sent the dollar skidding to a three-year low – and caused a scramble among investors and companies seeking to protect themselves against a further leg down.
“Whenever you have geopolitical or geoeconomic risk you see heightened volatility levels in FX. In this instance, it’s leading to some reflection and some capitulation around what’s been a 14-year bull market in the dollar and a confluence of events that has changed investor sentiment around it," said Samer Oweida, global head of FX and emerging markets at Morgan Stanley.
Oweida said the "multibillion" dollar question right now in the market is how investors will respond. "We’re very much in the first innings of those discussions, which is why bull or bear markets in FX can be so longstanding. It’s going to take time for these behavioural patterns to be priced in," he said.
A remarkable rally in the dollar came to a screeching halt earlier this year when the White House started levying tariffs on US trading partners. The selloff intensified after April 2 as concerns mounted over the economic drag from increased trade barriers and the potential for US markets to lose their long-held safe-haven status.
Dollar doldrums
Foreign investors reacted by hedging more of the currency risk stemming from their US investments. Denmark’s vast pensions and insurance industry increased hedging of dollar assets at the fastest rate in more than 10 years in March and April, according to Deutsche Bank.
BNP Paribas estimates Danish pension funds alone reduced their unhedged dollar exposure by about US$38bn during that period. The French bank also estimated the even bigger Dutch pension fund sector reduced its unhedged dollar exposure by US$53bn in the first quarter.
“We’ve had healthy client flows since the Trump inauguration [in January], but there was a step change in activity after April 2,” said the head of FX trading at a major bank. “Real users of FX – asset managers, pension funds, insurance companies – have started to trade a lot more [to hedge their dollar exposure] after not really being that active for the last few years.”
All this has provided a material shot in the arm for bank trading desks. BNPP, Deutsche, Goldman Sachs and Morgan Stanley all singled out the performance of their FX divisions in first-quarter earnings. Bank of America and Barclays also pointed to strength in macro trading, which typically refers to products linked to interest rates and currencies, while Citigroup said its rates and currencies revenues increased 9%.
“[The] surge in client activity to reshuffle investments and reposition hedges ... was very profitable for banks and other FX market makers,” said Angad Chhatwal, head of fixed income, currencies and commodities at Coalition Greenwich.
That looks to have continued into the second quarter as the global trade war escalated. CLS said average daily trading volumes submitted to the FX settlement infrastructure group hit a record US$2.5trn in April. That was the second consecutive month of record trading volumes at CLS, which has seen daily activity across forwards, swaps and FX spot increase notably in the first five months of the year.
Hedging options
Options have been the best performing product for FX trading desks this year, according to Coalition Greenwich. These derivatives are typically favoured by institutional clients like hedge funds and asset managers that can react faster to events than slower-moving pension funds and corporates.
Banks earned almost half as much revenue in FX options in the first quarter as they made on average over the course of a whole year in the past decade, Coalition Greenwich said. That has come amid some sharp market moves. One-year implied volatility on euro-dollar options jumped in April to the highest since the US regional banking crisis two years ago, according to LSEG data.
“The level of volatility and institutional client engagement have both been very high in the first five months of the year. That’s really moved the needle for the FX options business and made it a very good start to the year in terms of client volumes and the opportunity set," said Patrick Green, global head of FX options trading at Citigroup.
Many expect more hedging activity as foreign investors and corporates continue to adapt to the new environment – despite the potentially hefty costs involved. Oweida said clients believe FX has moved into a higher volatility regime over the medium term, which should lead to an increase in activity.
“A lot of FX is clients hedging out their exposure," he said. "When you expect that vol is going to be low, there are fewer consequences for not hedging, but when you expect vol is going to be high, generally, you're inclined to hedge."
