Can banks prop trade FX and Rates product or not?
Question speak for itself, can FICC trading teams (FX, Rates, Derivatives, EM...) run their own prop trading strats on top of market making?
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Yes
kind of
Yes. Treasuries (and possibly other products) are exempt from Volker regulations and any market marker that holds inventory prop trades to a minor extent each day. In my experience, the treasury trading desk, especially on the long end spend half their day (and most of their pnl comes from this) taking curve positions
FX on the other hand is largely all e trading anyway so not much room to prop. Most banks still haven’t automated long end treasury though
Automation has nothing to do with taking discretionary risk. If you want to go long 100 USDJPY and hold it for a day, a week, or a month, you can do that at a FX spot trading desk at a bank. That is prop trading. What does affect the success and viability of prop trading is volatility in the market. When there is no volatility it makes it much more difficult to be successful in this type of "macro prop" trading style.
I think you are confusing "prop trading" with market makers out there that are often called "prop traders" like Optiver, DRW, etc. They are called prop traders because they don't have clients, but their bread and butter is very much from market making and running algorithms/strategies that rely heavily on flow.
FX spot is omitted from the Volker rule. Hence banks can have prop FX spot desks on top of market making activities . Mosts if not all do. Other desks like rates, FX options function more as market makers as there are still large enough spreads to the gained from such activities. However, banks can hold proprietary rates positions to "pre-position for client flow" in order to provide "liquidity".
https://www.ecb.europa.eu/paym/groups/pdf/fxcg/Volcker_rule.pdf?5700b45…
FX spot is omitted from the Volker rule. Hence banks can have prop FX spot desks on top of market making activities . Mosts if not all do. Other desks like rates, FX options function more as market makers as there are still large enough spreads to the gained from such activities. However, banks can hold proprietary rates positions to "pre-position for client flow" in order to provide "liquidity".
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