Hedge Funds Dominate FX Trade in Market Shocks as Investors Flee

(Bloomberg) -- When major turbulence hits currency markets, hedge funds ramp up trading, while other investors -- who could have a steadying influence on prices -- stay on the sidelines.

That’s one observation from a study of foreign-exchange trading carried out by the JPMorgan Chase Institute, part of the largest U.S. bank. Its authors combed through data on 395 million trades by institutional investors around three tumultuous events: the U.K. Brexit vote and U.S. presidential election in 2016 and the Swiss National Bank scrapping its currency cap a year earlier.

“During the really violent repricing periods, we really only see hedge funds and market makers participating in the price discovery process,” Kanav Bhagat, the institute’s director of research and former global head of rates trading at the bank, said by phone. “What was more surprising was the absence of all the other investor sectors when the market was really moving,” said Bhagat, who co-authored the report.

The increased influence of the fastest, most active traders during volatile periods has implications for financial stability, the authors wrote.

Central bankers can use the analysis of market reactions to weigh “what’s the value and cost” of surprise decisions, Diana Farrell, president and CEO of the institute, said by phone. Policy makers can consider the behavior of institutional investors “as they pursue the appropriate balance between transparency in communicating policy actions and other critical factors, such as maintaining their credibility,” she said in a statement.

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