Foreign exchange activity is concentrated in four ‘major’ currencies in trades against the USD - EUR, JPY, GBP and CHF.

This concentration of liquidity in a few currency pairs reflects the importance of the underlying financial and physical product markets denominated in those currencies.

The US dollar (USD)

The USD is the world’s dominant currency, being on one side of around 80% of all FX trades.The economic and political significance of the USA makes the dollar the worlds most heavily traded currency.

The USD is the most widely used safe-haven currency for global investors. Reasons for this include the fact that:

• the currency is prudently managed by the US Federal Reserve Bank;   
• US contracts are safe-guarded by a robust legal system;   
• and the Treasury bill market is always deep and liquid.

In addition, the scale, diversity and sophistication of financial instruments available in US markets attracts foreign investors with more limited domestic opportunities.

• US money markets are readily tapped for borrowing purposes and are a safe investment for lenders;   
• the government bond market is the deepest and most liquid in the world;   
• private sector bonds and equities provide the widest range of investment opportunities;   
• and each cash market is mirrored by deep, liquid derivatives markets which offer efficient hedging tools and speculative position-plays.

So the USD attracts the central banks to hold the majority of foreign currency reserves in US T-bills; and it attracts the entire range of private investors, from the risk-averse, holding US Treasury bonds, to the most speculative players looking for high returns from growth stocks, high-yield bonds and open futures and options positions.

The euro (EUR)

The euro takes over from the German Deutschmark as the world’s second largest trading currency.

Before the advent of the euro, the DEM accounted for 25% of all FX transactions, with USD/DEM being the most liquid and traded pair. The euro will expand on this. Not only does the euro also take in the French franc and 10 other European currencies, it is also expected to stimulate the growth of the EMU‘s euro-denominated debt and equity markets, which have the potential to rival US financial markets in terms of depth and liquidity.

The Japanese yen (JPY)

The third most traded currency is primarily active against the USD and EUR. Liquidity is substantially reduced against other currencies. The Japanese demand USD for investment purposes, to service USD debt and to import oil, gas and commodities.

Japan’s domestic financial markets are difficult for foreign players to access. As such, demand for yen is predominantly from Japanese companies repatriating trade profits, investment returns and debt capital. The yen is particularly sensitive to the profitability of these companies and to the domestic property market.

British pound (GBP)

The GBP is most heavily traded against the USD and EUR and over half of these trades are through London, the major FX trading hub.

London and the GBP were at the centre of all FX activity before the rise of the USD. Britain and the USA maintain a historic two-way investment relationship, with many US companies investing and operating in the UK and vica versa.

As the British economy is now far smaller and has been far less fundamentally stable over time than than the USA and Germany, it has made for highly volatile currency pairings with the USD and DEM, giving London dealers in particular, many opportunities for speculative position plays.

Swiss franc (CHF)

The Swiss economy does not warrant its currency’s place in the ‘big five’, but the nature of its society does .

It is demanded as a major currency because Switzerland is seen as the safest safe haven for investors. The economy and society are conservative and stable. The banking system still maintains a strong reputation for strict confidentiality and excellent customer service. And, as long as (for whatever reason) investors fear for the safety of their assets, then some global funds will always move into CHF.

The CHF has tracked the DEM and is tracking EUR, but it tends to be more volatile as the lack of liquidity in CHF means that large size orders will move market prices far more readily than in the other major currency markets.