[FX] Is it normal for exotic pairs to have such huge spreads (+200 pips)?
I’m a European student doing a summer internship at a Maghrebian bank before starting my master to gain a bit of expierence, and I’m assigned to the currency desk. Their main activity is being market makers (with some directional risk via prop trading), mostly spot and a little vanilla options (almost exclusively calls/puts).
But the spreads are insane. The senior trader told me they typically have 150 pips, and even for their biggest client (a huge conglomerate in the country) they never drop below 50 pips.
I simulated their P&L using the daily volume they said the bank trades, then applied 20% for infra/support costs and divided by 10 to see what the desk actually keeps. I got roughly $500k per year to split among four people on the desk (bear in mind it’s a developing country where the median salary is around €500/month). It seems crazy for a relatively neutral business, so I wanted to know if I’m missing something or if seeing such wide bid/ask spreads on exotic pairs is common? If so, is market making in these countries especially profitable?
Wide bid/ask spreads on exotic currency pairs are indeed common, especially in developing markets. Based on the most helpful WSO content, here’s why this happens and why it can be profitable:
Liquidity Constraints: Exotic currency pairs often have significantly lower trading volumes compared to major pairs like EUR/USD or USD/JPY. This lack of liquidity leads to wider spreads as market makers need to compensate for the higher risk of holding positions that may be harder to offload.
Higher Volatility: Exotic currencies are more prone to sharp price movements due to political instability, economic uncertainty, or limited central bank intervention. Wider spreads help market makers manage this additional risk.
Operational Costs and Risk Premiums: In developing countries, infrastructure, regulatory, and operational inefficiencies can increase costs. Market makers price these into the spreads. Additionally, the lack of competition in such markets allows for higher spreads.
Client Base and Market Power: In your case, the bank seems to have significant market power, especially if they are one of the few market makers in the region. This allows them to maintain wide spreads even for large clients, as there may not be many alternatives for those clients.
Profitability in Developing Markets: As you noted, the desk’s profitability seems high relative to local salary standards. This is typical in developing markets where the cost of living and wages are lower, but financial services can still generate substantial revenue due to the wide spreads and limited competition.
In summary, the wide spreads you’re observing are not unusual for exotic pairs in developing markets. Market making in such environments can indeed be highly profitable, especially when combined with low local costs and limited competition.
Sources: Q&A: Emerging markets investment analyst, https://www.wallstreetoasis.com/forum/trading/converts-trading?customgpt=1, Traders lose money, Q&A: Emerging markets investment analyst, Q&A: BB Fixed Income Trader, 2nd Year Analyst
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