January Month-End Model Suggests Strong Dollar Rally, Pending GDP

Background:

Traders often refer the impact of ‘month end flows’ on different currency pairs during the last few days of the month. In essence, these money ‘flows’ are caused by global fund managers and investors rebalancing their currency exposure based on market movements over the last month. For example, if the value of one country’s equity and bond markets increases, these fund managers typically look to sell or hedge their now-elevated exposure to that country’s currency and rebalance their risk back to an underperforming country’s currency. More severe the monthly changes in a country’s asset valuations lead to larger portfolio adjustments between different 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 are often 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 portfolio managers scramble to hedge their overall portfolio ahead of the European market close.

2015 kicked off with a bang as global central banks eased across the board. In addition to the ECB’s landmark decision to embark on a massive QE program, central banks in Canada, Switzerland, Denmark (three times!), Singapore, Turkey, India, Peru all cut interest rates. This surge of global liquidity had mixed effects: stocks in Europe surged (hitting new all-time highs in some cases), as did global bonds and gold, while US stocks struggled and oil extended its downtrend to a new 6-year low at $44.00.

In aggregate, the inflows into European stocks and bonds dwarfed those of the US this month, leaving traders underexposed the US dollar. As a result, our model is showing a strong bullish-USD signal in five of the six currency pairs we track; the lone exception is USDCAD, which just missed the $400B threshold. Traders should also note that tomorrow morning’s US Q4 GDP release comes near the peak month-end rebalancing time window, suggesting that we could see a particularly strong bullish reaction if GDP beats the 3.0% expected reading.

Source: FOREX.com