CME CHAIRMAN EYES VOLATILITY REBOUND
- By Tom Osborn
With volumes across the world’s futures markets slumping by between 10% and 25% during the first quarter of 2012, many exchange leaders have begun decrying the impact that persistently low volatility is having on trading in their core derivative products.
But on the exchange's first quarter earnings call yesterday, CME Group chairman Terry Duffy pointed out the wood many others can't see for the trees; the price of everything from oil to interest rate futures are either jammed near record highs or record lows.
"That tells you volatility has to move," the market veteran told analysts and global media. "It's a matter of pure fundamentals."
Volatility is a double-edged sword for investors and trading firms. On the one hand, sharp price movements offer profitable trading strategies. But on the other, excessive volatility can deter investors from entering the market.
Duffy's comments came after volumes across the CME were off 11% during the first quarter, contributing to a 42% slump in profits. Outlining the exchange's performance, incoming chief executive Phupinder Gill said: "During the first quarter, volumes remained constrained by low volatility and directional uncertainty."
The two factors feed one another; prices stabilise as investors get nervous and pull back from the market. That in turn feeds further investor uncertainty, scuppering directional trade strategies (how do you spot a trend if something's price isn't moving?), leading to a self-fulfilling cycle of lower trading volumes.
Gill also acknowledged that lower volatility had contributed to a decrease in activity from high-frequency trading firms – big boosters of exchanges' volumes and coffers. Fewer price moves to follow means fewer algorithmic trading strategies can be employed.
Take oil, for instance. With the price of flagship oil contracts on CME's Nymex platform stuck near post-crisis highs for the past few months, volatility is at rock-bottom. The CBOE Oil Volatility Index, which measures price fluctuations in Nymex oil futures, yesterday fell to five-year lows.
Or take a look at CME's core FX products. Gill talked about the impact sovereign interventions in the currency markets – most notably weakening actions by the Japanese and Swiss central banks – was having on the exchange's FX trading volumes. Both countries have artificially pegged their currencies to others, limiting their ability to fluctuate and distorting their true market price.
The trend has had a marked impact on other FX platforms such as EBS, the interdealer broking platform owned by Icap. With price movements in major currencies limited, many arbitrage opportunities between the two platforms have disappeared, say brokers – something which has sapped volumes on both platforms.
Gill refused to be drawn on specific volume expectations over the coming months, or on whether a lack of recovery in volumes would spell further voluntary redundancies. The exchange confirmed on the call that headcount had declined by 35 people during the first quarter, to 2,702.
But according to Duffy's logic, even if demand for the exchange's core products remains weak, supply-side factors will eventually force investors' hands. At some stage, even in the face of weak demand, supply issues have to tell. US oil supplies will be exported to higher-premium world markets, interest rates will eventually have to rise, and foreign central banks will have to cease buying up other currencies.
If Duffy is right and prices begin to shift again, investors and risk managers will flock back to the market. And with directional trade strategies and renewed hedging activity on the rise, algo piggyback trades will likely rise too – pulling trading volumes higher in their wake. Lower trading activity this quarter therefore likely doesn't indicate a "structural shift," Gill concluded.
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