| HONG KONG
HONG KONG Trading desks normally love volatility but Asian operations have found little joy in recent wild swings, undercut by investors' brutal reassessment of the region's prospects as they prepare for the end of unlimited cheap cash from the United States.
The massive monetary stimulus from the U.S. Federal Reserve and other major central banks of recent years has cheaply funded investments in emerging markets, such as high-yield bonds.
But with the Fed saying it may be time to start pulling back and China and India slowing significantly, investors don't want to be left holding high-risk assets as their funding costs rise.
"With the markets under pressure now, that underlying liquidity has vanished," said the head of Asian fixed income trading at a U.S. bank in Hong Kong. "So to get into emerging markets now is a bit like catching a falling knife."
A credit crunch in China last month, the Indian rupee's plunge to record lows and a strengthening U.S. dollar have added to the reluctance to buy in, and trading volumes are falling.
"We are hardly seeing any inflows on the institutional side on the FX or the fixed income space in Asia," the trader said.
"Most clients that we talk to are sidelined and waiting for a further weakening of the market."
The shrinking of the pool of money at work in Asia has hit volumes across assets even as volatility has risen, which is a worry for banks that have ramped up their regional presence as Asia drove the world economy after the global financial crisis.
Trading revenue at large investment banks is typically two to three times the size of revenue from other activities such as managing stock listings and advising on mergers.
Asia Pacific ex-Japan stocks .MIAPJ0000PUS fell 17 percent over May and June, have since recovered 8 percent from their lows. Over that period there were 10 days when daily price moves were well above average.
But trade volumes on Asian stock exchanges have fallen below average levels, while currency and secondary market bond trading has dwindled as the hunt for yield has came to an abrupt halt.
Last week, turnover on the Hong Kong exchange hit its lowest weekly level this year, while in South Korea the weekly volume of foreign trading for the most liquid 3-year treasury futures in Korea .VMF.KTB -- a proxy for the regional local currency bond market -- is near its lowest point this year.
Bank of America Merrill Lynch's survey of fund managers shows the prospect of the Fed tapering its stimulus and China's economic growth slowing to two-decade lows has driven emerging market equity allocations to their lowest level in 12 years.
And with the sudden turnaround in sentiment, foreign investors who have bought local currency bonds on an unhedged basis find themselves hit by a double whammy of depreciating currencies and a spike in market volatility.
Take India, for example. Foreigners piled into the Indian government bond market in the first five months of the year attracted by a steady currency, low volatility and relatively higher yields, buying about $5 billion of bonds.
Since June, however, nearly $8 billion has flowed out of the market as a sharp plunge in the currency erased all gains on holding the debt.
Even after such sharp outflows, positioning in Asia's markets still appears to carry some risk.
UBS estimates cumulative flows since 2009 into both emerging market debt and equities are down by an average of only 13 percent from their peak levels, suggesting more outflows are possible in the near term.
"The dislocation you saw in credit markets in China last month has scared investors off. It's like the cat is out of the bag now," said Andrew Swan, head of fundamental equities for Asia Pacific at Blackrock.
(Editing by John Mair)