Currency Pair Spread Determinants

The bid-ask spread in a currency pair—the gap between the price a dealer will buy and the price it will sell—varies dramatically across pairs. The dollar-yen pair might trade at 1 pip wide, while an emerging-market pair trades 100 pips wide, even on the same day during the same market conditions. The difference is not arbitrary: it reflects liquidity (how much volume is typically traded), volatility (how much prices move), and the cost structure of market makers.

Liquidity: the primary determinant

The single strongest predictor of a currency pair’s spread is how much volume trades in it per day. The EUR/USD pair has enormous liquidity—hundreds of billions of dollars trade daily between banks, hedge funds, corporates, and retail brokers across multiple venues and time zones. That volume creates competition: if one market maker quotes a wide spread, another will undercut it and capture the trade. The result is typical spreads of 1–2 pips on EUR/USD, with even tighter spreads during peak London and New York hours.

Compare that to a pair like the Mexican peso-Chilean peso: very few banks quote it, few corporates need to trade it, and there is no active speculative market in it. A market maker in that pair faces the risk of holding inventory (being short or long pesos) for hours or days without a matching counterparty appearing. To compensate for that inventory risk, the dealer widens the spread to 100+ pips. The wider spread is the price of illiquidity.

Size of the market matters, but so does fragmentation and regulation. The EUR/USD pair is quoted not just on the interbank market but on electronic communication networks (ECNs), some retail platforms, and traditional dealing desks. That fragmentation and competition keep spreads tight. A pair with all trading concentrated in a single bank’s dealing desk will have a wider spread because there is no competitive pressure.

Volatility: uncertainty premium

Even a liquid pair widens its spread when volatility spikes. During the 2008 financial crisis or in March 2020 (when COVID-19 triggered a major sell-off), even the EUR/USD pair saw spreads widen from 1–2 pips to 5–10 pips or more. When prices are moving fast and unpredictably, a market maker who buys at the bid runs the risk that the price falls before a seller arrives; conversely, selling at the ask risks the price rallying away. The wider spread compensates for that added risk.

Volatility is particularly important in exotic and emerging-market pairs. The Brazilian real against the US dollar is moderately liquid, but Brazil’s political and economic volatility means spreads are typically 5–15 pips, sometimes much wider. During a currency crisis in Brazil, spreads can exceed 100 pips as dealers protect themselves against the risk of sharp moves.

The relationship is not perfectly linear. During truly severe crises, even major pairs can see spreads blow out to extreme levels because uncertainty becomes so high that dealers effectively stop quoting—they refuse to take inventory at any reasonable spread. This happened in 2008 to many currency pairs and to over-the-counter-market instruments more broadly.

Time of day and regional factors

Spreads also vary by when you trade. The EUR/USD pair trades tightest during the overlapping hours of the London and New York sessions (roughly 12:00–17:00 UTC), when the most dealers are active and volume is highest. Outside those hours—say, during early Asian or late North American trading—spreads widen because fewer dealers are active and volume dries up. A pair like USD/JPY, which is very active during Asian hours (Tokyo is a major forex hub), may actually trade tighter in the Tokyo session than in New York.

Regional pairs also benefit from local liquidity. The EUR/GBP pair is tightly traded because both currencies are heavily used in Europe and the UK; banks and corporates in London and Frankfurt quote it constantly. A pair like USD/SGD (dollar-Singapore dollar) is tightly traded in Singapore but wider elsewhere. Central banks sometimes manage spreads by being active dealers themselves; the Monetary Authority of Singapore, for instance, is a major dealer in the Singapore dollar, which helps keep spreads competitive.

Counterparty and credit risk

During periods of elevated counterparty risk—for instance, when a large bank is rumoured to be in trouble or when emerging-market central banks are suspected of running out of reserves—spreads widen in that bank’s or country’s currency pairs. In 2010, when several European sovereign-debt crises loomed, spreads in EUR/GBP and other euro pairs widened even though the pairs themselves were highly liquid, simply because traders worried about counterparty exposure to European banks.

The risk is especially acute in non-deliverable forwards (NDFs)—contracts on currencies that are not freely convertible or tradable in the over-the-counter-market. In those markets, there is no transparent price discovery and very few dealers, so spreads can be hundreds of pips. The NDF market in the Chinese yuan, for instance, trades with spreads far wider than the onshore yuan because the onshore currency is tightly controlled and illiquid in the offshore primary market.

Market-maker costs and pass-through

A market maker has three main costs: funding costs (the cost of capital to hold inventory), operational costs (technology, compliance, staff), and hedging costs (the cost of laying off risk to other dealers or central counterparties). On a major pair like EUR/USD with thousands of quotes per second, these costs are spread across so much volume that they amount to a fraction of a pip. On an exotic pair with occasional trades, those same costs might justify spreads of 50 pips or more.

Spreads also tend to widen when interest rate differentials between the two currencies widen, because funding a position in one leg becomes more expensive. If the US dollar interest rate is 5% and the euro rate is 0%, a dealer holding EUR/USD inventory has a funding cost. If the rate differential widens to 6%, the spread often widens with it as dealers demand higher compensation.

Patterns across market regimes

Spreads in major pairs tend to be positively correlated with equity volatility—when stock markets are calm, forex spreads are tight; when stock markets are turbulent, even the largest forex pairs widen. This is because many of the same dealers and investors operate in both markets, and volatility in one generates demand for hedging in others, increasing activity and uncertainty across asset classes.

See also