Statistics on foreign exchange transactions--new insight into foreign exchange markets.

• Author: Meyer, Erik

Norges Bank has published new statistics on the purchase and sale of NOK for foreign currency. The statistics provide information about activity in the market for NOK, and will be an important aid in monitoring and identifying mechanisms in the NOK market. The statistics on foreign exchange transactions show that the average daily turnover in NOK of reporting banks in the period October 2005--January 2006 was over NOK 63 billion. Foreign banks dominate trading in the spot and swap markets, while non-financial enterprises are the largest operators in forward markets. NOK/EUR trading makes up the bulk of spot transactions, while NOK/USD trading dominates swap transactions. The currency distribution in forward transactions is more even.

1 Introduction

1.1 Purpose and application

The statistics on foreign exchange transactions are based on daily transaction data on the purchase and sale of NOK for foreign exchange from the largest banks. The transactions are classified according to counter-party sector, type of contract (instrument) and maturity. The foreign exchange statistics strengthen the information used as a basis for monetary policy by relating activities in the foreign exchange market to developments in the krone exchange rate. The new statistics provide up-to-date information on the customer groups that have been active and what types of contract they have used. Through contact with market participants, Norges Bank will be able to identify the causes of the shifts captured by the statistics. In the future the underlying data will also contribute to research on exchange rate theory. In the surveillance of financial stability, statistics provide a new source of information on turnover and maturity distribution in the currency hedging market for NOK.

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Norges Bank's statistics on foreign exchange transactions have features in common with Sveriges Riksbank's system for collecting transaction data from the foreign exchange market. The Riksbank publishes its turnover statistics on a monthly basis, while the Norwegian statistics are published weekly. (1) Norges Bank's statistics have a more detailed breakdown into customer categories and contract types. Norges Bank has based its breakdown by customer and type of contract on the results of recent research on order flow analyses (see Section 1.2). We are not aware of other central banks that collect microdata from the foreign exchange market with the same frequency and degree of detail.

The collection of data for the new foreign exchange transaction statistics started in October 2005. The figures for the period to end-January 2006 show that the average daily turnover of NOK (volume) in the foreign exchange market was over NOK 63 billion for the reporting banks.

The highest turnover was in January 2006, when sales and purchases of NOK averaged NOK 68 billion per day. Swap transactions dominated trading, with a share of 66 per cent of turnover throughout the period October-January, while spot and forward transactions accounted for 26 per cent and 8 per cent respectively. Swap trading is characterised by large volumes, but relatively few trades. Swaps only accounted for 5 per cent of total transactions of all types of contracts. The shares for spot and forward contracts were 79 per cent and 16 per cent, respectively.

1.2 Theoretical and empirical background

The foreign exchange transaction statistics are based on an analytical model called order flow analysis. Order flows are defined as the difference between the value of buy and sell orders initiated by customers in a period, i.e. customers' net foreign exchange purchases. Order flow analysis has proved useful in explaining developments in a number of asset prices, including exchange rates.

Exchange rates can be influenced through two information channels--a direct channel and an indirect channel (Evans 2005). The direct channel consists of publicly available information. For example, information on developments in GDP, the CPI, credit or employment can provide unambiguous, simultaneous information to the market makers, and can influence the exchange rate immediately. In traditional macroeconomic models of the exchange rate, it is assumed that all market makers receive the same information simultaneously and have identical expectations of future economic developments.

The indirect channel functions through information that is not generally known (private information). Examples of private information are micro-level knowledge of earnings, buy and sell orders and internal financial analyses that lead to different expectations with respect to exchange rate developments. Private information reaches the individual market-maker via customer order flows. The order flows provide signals about the direction and strength of any exchange rate adjustments. It can take time for exchange rates to reflect these signals: the information has to be interpreted, the signals have to be distinguished from noise and the information has to be disseminated to the market as a whole via interbank trading. The order flows and the trading process form an integral part of the determination and development of spot prices (Lyons 2001). (2) Models that take account of order flows to explain exchange rate developments are often called micro-based models. Micro-based models make it possible for exchange rate effects to come through both the direct and the indirect channel. Love and Payne (2002) and Evans and Lyons (2003) find evidence that both channels play a part. In practice, models based on order flow analysis are often used in combination with fundamental and technical analyses. A number of empirical studies show that order flow analyses have good explanatory power in the short and medium term, in contrast to fundamental analyses. Evans and Lyons (2005) show that micro-based models also have better forecasting power than both standard macro-models and random walk models with a horizon of from 1 day to 1 month.

Order flow analyses based on daily transaction data have not previously been carried out for large parts of the Norwegian krone market. In general, customer trades are only observable for the individual bank, and a number of these have so far used their own data in order flow analyses. The information in foreign exchange transaction statistics obtained by grouping microdata from a number of banks may therefore make an important contribution to the development of order flow analyses in the future.

2 Description of the statistics

The foreign exchange statistics provide information about the reporting banks' purchase and sale of NOK for foreign exchange, the counterparties in the transactions and the types of contract used. The reporting banks are all the Nordic banks that set prices in NOK. A considerable part of the NOK trading of the reporting banks takes place abroad, through a head office or branches. This applies in particular to interbank trading, options trading and trading with large customers. In order to capture the total activity of the reporting banks, the rule is that all trading in NOK that takes place through the banking section of the conglomerate is reported, irrespective of where in the world the trading takes place. It is difficult to quantify the total NOK turnover in the foreign exchange market. The Triennial Central Bank Survey of Foreign Exchange and Derivatives Market Activity conducted by the Bank for International Settlements (BIS) measured daily turnover in April 2004 of NOK in the foreign exchange market at just over NOK 91 billion. The foreign exchange transaction statistics for the period October 2005--January 2006 cover 69 per cent of this daily turnover. No adjustment is made here for double counting of figures due to the fact that the reporting banks trade with one another. The main reasons that the foreign exchange trade statistics do not have higher coverage are that the statistics only cover some foreign banks, and that not all reporting banks have complete consolidated...