FX QUANT LAB: February Month-End Rebalancing

Backdrop:

Often you may hear about ‘month end’ flows having a positive or negative effect on a currency during the last day(s) of the month. Thus, we’ve decided to take a look at asset market capitalizations in the major market economies to help us try to determine which direction these ‘flows’ may move. Typically, the largest impacts are seen into the 11am ET fixes (of the last few days of the month) as hedge and/or mutual fund portfolio managers scramble to rebalance their remaining currency exposure in order hedge their overall portfolio.

Market capitalizations for February were mixed across the board – The largest gain was seen in Japan which saw a rise of 164B on the month, while the largest decline was in the EU (collectively), falling 171B (as of 2/25 close). So how do we make sense of this? Well, the more severe a change of the principal assets (primarily equities and bonds), then the more likely portfolio managers are either under or over-exposed to certain currencies. Our model suggests that their exposure is essentially right where it should be, consequently they may not need to meaningfully adjust their USD positioning.

In the chart below we have outlined the expected directional movement broken down pair by pair based upon our proprietary month-end model. Customarily, a reading of +/- 400K on the month produces a stronger bullish or bearish signal. With that said, none of the currency pairs satisfy the aforementioned +/- 400B level on a monthly basis – Thus, we believe the buck is unlikely to see a substantial impact from these flows heading into Thursday’s fixing.

However, a potentially more intriguing way to look at this over the coming days could be in the JPY-crosses, with EUR/JPY and GBP/JPY producing bullish signals. That said, if any of the global equity markets see a rather large gain or loss on the day, and accordingly a change in market capitalization which would meaningfully change the signal, then we’ll post an updated chart of the Rebalancing Model on Twitter.