September Month-End Model Favors Slight USD Strength

Background:

Traders often discuss how ‘month end’ flows may impact a currency or a currency pair during the last few day(s) of the month. These flows are caused by global portfolio managers rebalancing their existing currency hedges. If the value of one country’s equity and bond markets increases, these money managers typically look to sell or hedge their elevated risk in that country’s currency and rebalance their exposure back to an underperforming country’s currency. The more severe the change in a country’s asset valuations, the more likely portfolio managers are either under- or over-exposed to certain currencies.

In order to predict these flows and how they impact FX traders, we’ve developed a model that compares monthly changes in total asset market capitalization in various countries. In our model, a relative shift of $400B between countries over the course of a month is seen as the threshold for a meaningful move, whereas monthly changes of less than $400B can be easily overwhelmed by other fundamental or technical factors. As a final note, the largest impact from month-end flows is typically seen heading into the 11am ET fix (often in the hour from 10 & 11am ET) as hedge and/or mutual fund portfolio managers scramble to hedge their overall portfolio ahead of the European market close.

Global market volatility ticked higher in September as traders returned from their summer cabins and were greeted by a number of high-impact developments, including major meetings at the Fed and ECB, the tight Scottish Independence vote, and an incredible (as in, likely not credible) Australian jobs report. Overall, global stock and bond markets have been fairly mixed over the last month, suggesting that month-end rebalancing flows may be fairly limited this month.

Our model’s strongest signals are bullish USDJPY and USDCHF, but even those signals do not reach our +/- $400B threshold for a meaningful move. Meanwhile, the widely-traded EURUSD and GBPUSD are forecast to see hardly any change on month-end flows. In the end, traditional technical and fundamental factors (including a data-packed economic calendar) are likely to be the most important developments to watch this week.