By Anirban Nag and Laurence Fletcher
LONDON, Dec 8 (Reuters) - Daily turnover in the foreign exchange market fell 6 percent to $5 trillion a day in October, as trading in the yen and the euro declined, an analysis by the Bank for International Settlements showed on Sunday.
Volumes hit a high of $5.3 trillion in April, led by a surge in yen trading as investors positioned for the Bank of Japan to introduce aggressive monetary stimulus to help revive the economy. That resulted in the yen weakening sharply against most major currencies.
But interest faded somewhat in the second half of the year due to the sheer weight of bets against the yen.
At the same time, uncertainty over when the Federal Reserve would begin withdrawing its stimulus and a political stand-off over the U.S. budget prompted many investors to stay on the sidelines, holding down volumes. That has hurt revenues for a number of large banks who rely on trading activity to bolster their bottom lines.
Activity in the euro also took a hit, the BIS said in an update to its three-yearly snapshot of the foreign exchange market, which was first released in September.
It said spot trading in euro/dollar between September 2011 and October 2013 fell by $400 billion, leading to a drop in the euro's share.
The BIS analysis said spot trading overall had fallen to $1.8 trillion a day from above $2 trillion in early 2013. In contrast, trading activity in FX swaps, often used to hedge positions and exposure to assets, has fluctuated between $2 trillion and $2.2 trillion per day since early 2011.
HEDGE FUNDS AND ALGOS
Despite the drop in volumes, the BIS analysis showed that the cost of trading currencies had dropped. This has attracted many new participants from hedge funds to machine-driven traders to the foreign exchange market in the past few years.
Data showed hedge funds and high-frequency trading firms together account for 11 percent of currency market volumes. And non-reporting banks - usually smaller, regional commercial or publicly-owned banks - made up around 24 percent of the market. They are clients of large FX dealing banks but do not engage in market-making in major currencies.
Hedge funds' influence in some areas was more dominant - they account for 17 percent of forwards volumes and 21 percent of options volumes. This was boosted by a rush into dollar-yen options early this year to bet on Japan's easy monetary policy.
But some trades by hedge funds - which run money for wealthy clients and institutions - have gone awry.
Carry trades - borrowing a low yielding currency to invest in a search for higher returns - and bets on market trends have suffered as differentials between interest rates have fallen and currencies have traded in narrow ranges.
As a result, the assets run by currency hedge funds specialising in computer-driven trade slid to around $10 billion from more than $30 billion before the credit crisis.
Nevertheless, macro funds, which trade a wide variety of assets including currencies, have more of an influence, and were likely drivers of yen volumes in late 2012 and early this year, according to the BIS review.
High-frequency traders, who trade their own money with lightning-fast computers, are becoming important players in the market, accounting for 30-35 percent of volumes on the EBS trading platform.