With the holidays officially upon us, we have witnessed a rather lackluster trading session as many traders either left early or have taken the day completely off. Outside of USD/JPY, which broke to fresh 2012 highs and looks poised to test the psychological/option related 85.00 level over the coming sessions, there really was very little else moving in the markets. Furthermore, with the way the calendar falls this year between Christmas and New Years, we could see a similar market environment for the remainder of the year.
So faced with the fact that we are likely to see a continued thin and illiquid trading, we wanted to see if any other forces could sway the risk trade over the coming days (besides the “fiscal cliff”). Accordingly, we turned to potential month & quarter-end flows to see what type of measured impact they may have when traders get back on Wednesday.
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. This same concept applies for ‘quarter-end’ as well.
Market capitalizations for December were nearly all positive across the board, but gains were tepid at best and for Q4 we saw rather mixed results – The largest gains was seen in the EU which saw a rise of over 225B on the month and nearly 500B on the quarter (as of 12/23 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 models suggest that both on a monthly and quarterly basis they are essentially right where they should be, consequently they may not need to meaningfully adjust their USD exposure – Models see slight USD selling on the monthly, whereas a bit of USD buying on the quarterly).
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 (Exhibit 1) and +/- 900K on the quarter (Exhibit 2) produces a stronger bullish or bearish signal. With that said, none of the currency pairs satisfy the aforementioned +/- 400B level on a monthly basis, nor do they meet the +/- 900K threshold for the quarter. Therefore, we believe the buck is unlikely to see a substantial impact from these flows heading into next Monday’s fixing.
That said, if any of the global equity markets see rather large gains or losses over the next few days (thus a change in market capitalization) which would meaningfully change the signal, then I’ll post an updated chart of the Rebalancing Models on Twitter.