The FX markets are the largest financial markets in the world with an average daily trading volume of over $6 trillion. The trading volume in FX swaps, which is the most liquid FX derivative instrument, has exceeded that of spot for many years – by 2019, it accounted for almost half of all trading in global FX markets (Chart 1). But despite this, prior research on the liquidity in FX markets has focused disproportionately on the spot markets, rather than FX swaps. BIS economists Vladyslav Sushko and Ingomar Krohn address this by analysing FX swap markets. They find compelling evidence that the liquidity conditions in FX swap markets impact spot markets and vice versa.

Why Has Liquidity Worsened?

(1) Policy divergence

One of the main reasons appears to be policy divergence between the ECB, BOJ and the Fed. In recent years, the BOJ and ECB cut rates into negative territory, while the Fed raised rates (Chart 2).