This group makes up the vast majority of currency speculation and therefore of the currency market as a whole. The primary task of an interbank dealer is to provide liquidity and make markets in currencies for the bank’s clients. The principle is that all client positions have to be offset in the market (i.e. if a client sells you Euros against dollars, you the dealer are buying the Euros and therefore have to sell those Euros back to the market to keep a ?at exposure). In theory, the profit you make is the difference between your bid and the market’s offer. In practice, as bid–offer spreads have narrowed substantially, there has been a general shift within the currency markets towards keeping some exposures one gains or loses from clients in order to take speculative positions in the market to support the P&L of the dealing desk. In addition, a dealing desk can use the bank’s balance sheet to take speculative positions irrespective of client flow. Thus, while the reduction in bid–offer spread has reflected greatly increased information transparency and competition in the market, it has also resulted in a move to increase the “position taking” of an interbank or liquidity dealing desk. Such position taking may be more pro?table, and there is no question that it is when a highly experienced and professional chief dealer is in charge. However, this move has also undoubtedly added to the volatility of the dealing desk’s P&L. Equally, it may also have added to overall market volatility.
This may seem a contradiction, as narrower spreads should be a reflection of greater volume and liquidity. However, the reality is that as those spreads have narrowed, so position taking has increased. Larger positions are taken on by interbank dealing desks in order to maintain or boost P&L, and therefore as a result larger positions have to be unwound during periods of adverse price action. Equally, those narrow spreads can be an illusion. For instance, the normal spread in spot Euro–dollar may be one pip — i.e. 0.8910/11 — but try transacting USD500 million in that spread when the spot exchange rate is moving two or three “big ?gures” — 0.89 to 0.90 — a day!
Readers should note that when I say interbank dealers, I mean currency forward and options dealers as well as spot dealers. These also take positions as well as provide liquidity for the bank’s clients. Here too, like any market where competition has increased over time, spreads have narrowed and the emphasis to position taking has shifted proportionally. In addition, as the needs of clients have changed and become significantly more specific and sophisticated, so there has also been a move by forward and options interbank dealing desks to meet these needs with more exotic forward and options structures. The advantage for the bank concerned is that the spreads on these products are usually larger than those for plain vanilla forwards or options. However, markets work in real time. Here too, competition has quickly moved to narrow those spreads.
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