Liquidity in any market is to some extent a self-fulfilling prophecy, based upon collective 'I will if you will' confidence. As a result, a decline caused by fundamental factors can easily be exacerbated as participants lose faith and move to the sidelines. In the worst case, this behaviour accelerates into a downward spiral resulting in a drastic reduction in liquidity.
Happily, the largest FX trading platforms have proved relatively resistant to this doomsday scenario. Nevertheless, it is incumbent on these platforms to do all in their power to facilitate the efficient execution of business at current liquidity levels. Apart from fulfilling the immediate need, any initiatives that aid traders in this respect by implication also boost future confidence and inclination to participate.
The need for such action is apparent; the statistics speak for themselves. Figure 1 is drawn from a recent report by David Poole of ClientKnowledge and shows the general fall in buyside FX activity over the past six months based upon interviews with more than two hundred high volume FX traders. Figure 2 gives an insight into the sellside perspective, indicating a sharp decline in Tokyo market broker activity since October 2008. A similar situation prevails in FX futures and options; Figure 3 shows a commensurate decline in activity on the CME. While both FX spot and derivatives have shown signs of recovery more recently, overall activity is still well below typical levels for 2008.