GLOBAL – Pension funds are helping to drive activity in the foreign exchange market as part of a “global search for yield” the Bank for International Settlements says.

The BIS’s latest Triennial Central Bank Survey of Foreign Exchange and Derivatives Market Activity has found a surge in FX trading – with average daily turnover amounting to 1.9 trillion dollars in April 2004, a rise of 36%.

“This seems to have been driven by momentum trading and carry trades in a global search for yield on the part of institutional investors and leveraged players as well as by hedging activity,” the BIS said.

Momentum trading involves investors taking large positions in currencies aimed at exploiting long swings in exchange rates, the BIS explained. Carry trades are where an investor borrows in a low interest rate currency and takes a position in a higher interest rate currency.

The BIS noted: “Pension funds, insurance companies, mutual funds and other institutional investors have played an increasingly important role in financial markets in general, and in FX markets in particular, since the early 2000s.”

It saw a surge in trading between banks and financial customers – up 78% between 2001 and 2004.

“According to market participants, it involved a wide range of financial players: institutional investors (such as pension funds and insurance companies), hedge funds, commodity trading advisers (CTAs), proprietary trading desks of large commercial banks and COMs.

But the Basle-based BIS, the central banks’ central bank, warned that FX might not remain an attractive asset class due to a change in market conditions, lower US interest rates and the possible withdrawal of macro hedge funds from the market.

“So while the evidence supports the relative attractiveness of foreign exchange as an asset class, the level of investor interest in currencies is not certain to persist in the future.”

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