Currency crosses

What a cross is 

A cross is a currency pair in which neither side is the US dollar. EUR/GBP crosses the euro with the pound, GBP/JPY crosses the pound with the yen, AUD/NZD crosses the Australian dollar with the New Zealand dollar. The definition is entirely structural: it is about which currencies are absent, not about how heavily the pair is dealt or how large the economies behind it are.

The name is a survival from an earlier market. For most of the twentieth century, converting one non-dollar currency into another meant two transactions, both through the dollar, because the dollar was the only currency both counterparties were reliably quoted in. The resulting rate was described as a cross rate, meaning a rate arrived at by crossing two dollar rates rather than by dealing the two currencies against each other directly. Direct quoting is now ordinary and the two transactions are no longer necessary, but the arithmetic that produced the original cross rate still governs where the direct price can sit.

How a cross rate is derived 

The derivation is a single division or a single multiplication, and which one depends on how the two dollar pairs are quoted. When both currencies are quoted as the base against the dollar, as EUR/USD and GBP/USD are, the cross is the first divided by the second. When one is quoted as the base and the other as the counter, as EUR/USD and USD/JPY are, the cross is the two multiplied together.

The direct market and the derived rate cannot drift apart, and the reason is arbitrage rather than regulation. If a directly quoted cross sat meaningfully away from the rate implied by its two dollar legs, the difference could be captured by dealing all three pairs at once, and the dealing itself would close the gap. In practice the three prices stay consistent to within the cost of executing that sequence, which is why the derivation still describes the market even though almost nobody constructs a cross this way to trade it.

The consequence: two legs, one number 

Because the cross is tied to two dollar rates, anything that reprices the dollar affects both of them, and how much of that reaches the cross depends on whether the two legs move by the same proportion. A dollar move that lifts EUR/USD and GBP/USD by the same percentage leaves EUR/GBP where it was, since the ratio between them is unchanged. A dollar move that lifts one by more than the other shows up in the cross immediately.

This produces the property that most distinguishes crosses as a group. A cross is, in effect, a comparison between two currencies with the dollar divided out, so it isolates the relative standing of the two economies it names and suppresses the common dollar factor. A desk with a view about the euro area relative to the United Kingdom, and no view about the dollar, is expressing exactly that view in EUR/GBP and would be adding an unwanted dollar exposure by expressing it in the two dollar pairs separately.

It also produces the opposite property, which is where crosses are most often misread. A cross can move sharply on a day when neither of its own economies published anything, because a single large move in one of the dollar legs was not matched by the other. Reading a cross without reading its two dollar legs is the most common way that movement is attributed to the wrong cause.

The crosses that are dealt most 

• The euro crosses. EUR/GBP is the most heavily dealt cross of all and is conventionally read as the euro area against the United Kingdom. EUR/CHF is dominated by Swiss monetary policy and by the franc's behaviour when risk appetite falls. EUR/JPY, EUR/AUD and EUR/CAD extend the same construction to other regions.
• The yen crosses. GBP/JPY, AUD/JPY, CAD/JPY, CHF/JPY and NZD/JPY are the most volatile group in the ordinary cross universe, because the yen leg and the other leg have historically moved in opposite directions when risk appetite changes, so both legs contribute in the same direction at once. GBP/JPY has a long-standing reputation as one of the widest-ranging pairs quoted anywhere, which is a statement about its typical daily range rather than about its merit.
• The commodity crosses. AUD/NZD compares two economies with similar structures and is usually the quietest of the group. AUD/CAD, AUD/CHF, NZD/CAD and CAD/CHF are used to isolate one commodity exposure against another.

Turnover in a cross is a small fraction of turnover in either of its dollar legs, and the practical effects are the ordinary effects of less depth: a wider distance between the bid and the offer, less size available at each price, and a larger difference between the expected and the achieved price on a larger order. The gap is narrowest in EUR/GBP and widens steadily down the list.

When a cross is best quoted 

A cross is most heavily dealt when both of its home regions are awake, and that condition is stricter than the one governing a dollar pair, because the dollar is dealt everywhere while the two legs of a cross are not. EUR/GBP has a single wide window through the European session. The yen crosses are quoted in Asian hours and again through the European session, and the transition between the two is where their largest daily moves have historically been concentrated. AUD/NZD is effectively an Asia-Pacific instrument, and depth in it falls away sharply once Sydney and Wellington have closed.

Pip values on a cross 

The money value of one pip on a cross is calculated exactly as it is on any other pair: the pip size multiplied by the number of units the contract covers, which gives an amount in the quote currency. What differs is that the quote currency of a cross is never the dollar, so the amount has to be converted twice to reach an account denominated in a third currency, and the conversion uses a rate that is itself moving.