China's devaluation may be bad news for FX industry

Reuters News
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Posted: Aug 19, 2015 1:50 AM

By Jamie McGeever

LONDON (Reuters) - China's currency devaluation should give a shot in the arm to global foreign exchange volumes as traders take advantage of and protect themselves against the surprise surge in volatility, but its longer-term impact on market activity may not be so benign.

Investors with longer-term horizons than a day's trading profit, from pension funds seeking stable returns to companies considering expanding overseas, will be alarmed by the prospect of wild swings in exchange rates triggered by another round of "currency wars".

Former Brazilian finance minister Guido Mantega coined the term "currency wars" in 2010. It refers to countries trying to make their exports more competitive - and ultimately boost their growth - at the expense of rivals, by weakening their exchange rates.

Policymakers fear Beijing's move could accelerate this race to the bottom, particularly as most countries, including those in the developed and industrialized world, have few growth-boosting policy tools left open to them.

It's a worry for a troubled foreign exchange industry.

After years of rapid growth, which made it the world's largest financial market and a money-spinner for big banks, trading volumes are slowly shrinking and jobs are being lost.

Tighter regulation, increased automation, greater competition, and a global market-rigging scandal all suggest its glory days are over. The depressive impact on investment of a lengthy currency war would do little to restore its fortunes.

"Any prolonged uncertainty in the market resulting from this, and real-money players such as pension and mutual funds will be less inclined to invest," said Neil Mellor, senior currency strategist at Bank of New York Mellon in London.

Offshore yuan trading on Thomson Reuters platforms reached a record $26 billion on Aug. 12, the day after China devalued the yuan. It had grown 350 percent year-on-year in 2014.

On rival platform EBS - the main venue for dollar, yen and euro trading - the yuan ended 2014 as one of its top five traded currencies.

But the growth in yuan trading in recent years is atypical of the market at large, according to the latest FX trading volume data compiled by the Bank of England, New York Federal Reserve and global FX settlement system CLS.

Daily trading in London fell 8 percent to $2.48 trillion in the six months to April, driven by a 13 percent slump in spot volumes to $973 billion a day, the BoE said.

Average daily volume in North America fell 20 percent to $881.21 billion, thanks to a 25 percent slump in spot transactions to $426.99 billion, according to the New York Federal Reserve.

Data from CLS, used almost universally by the banking industry to process or settle foreign exchange trades, shows that global average daily volume slipped 0.6 percent to $4.61 trillion in May. As recently as last November the global FX market was turning over $5.17 trillion a day, according to CLS.

As analysts at Morgan Stanley point out, China accounts for 21 percent of the trade-weighted dollar index used by the Federal Reserve. It is the biggest single component of the equivalent euro trade-weighted index at around 23 percent. So what happens to the yuan has a growing influence on dollar and euro flows.

Analysts at London-based independent investment advisory firm Cross Border Capital say China's credit markets have grown 12-fold since 2000 and are now worth around $25 trillion - roughly the same size as U.S. credit markets.

"Her credit markets are fragile and they are unwinding what has been the world's biggest ever credit boom, and capital outflows are meaningful," they wrote in a report last month. "China remains the key risk and reward for global investors."

In that, the foreign exchange industry is no exception.

(Reporting by Jamie McGeever, editing by Larry King)