Something is afoot in the foreign exchange market.
Both Citigroup and Barclays Capital put out notes on Friday suggesting the market should be in for some sizeable dollar selling, on the back of month-end portfolio fixings by fund managers.
The idea is that to maintain an equal weighting, some portfolio managers opt to cash-in on the holdings that have outperformed in the period, reinvesting them in the sectors that have underperformed.
The dollar’s continued rally against the euro this month therefore would have hinted at some strong greenback selling on Friday.
Here was Citi’s point:
The month end hedge rebalancing model estimates net USD selling at the end of April. The outperformance of US bonds and equities over the month suggests that international investors will be net sellers of USD to maintain constant hedge ratios.
Based on the asset index closing values of 29-Apr-2010, we currently estimate the following direction of flow ahead of the WM/Reuters fix on Friday, 30-Apr-2010 [click to enlarge]:
Barclays Capital, meanwhile, explained:
Month-end fixing analysis: USD-sell signal, especially against EUR and GBP Equity market capitalizations (MSCI country indices) were up in the US and Canada (Figure 1). They were down in the euro area, Japan, the UK and Australia, with the euro area suffering an especially strong sell-off. Bond markets (BarCap aggregate bond indices) were up in the US, Japan, the UK, Canada and Australia. They were down significantly in the euro area, with a sharp fall in the last two weeks. The month-end fixing model suggests that the rebalancing behaviour of portfolio managers will result in USD sell signals especially against EUR and GBP (Figure 2).
But here’s the thing. There was also a similar signal last month.
While it definitely resulted in a dollar sell-off at the time, traders said it wasn’t half as much as might have been expected.
As MNI reported on March 30:
Trader chatter for several days has speculated on dollar sales to emerge in Wednesday’s session and the only surprise to the market was, perhaps, that such flows were relatively modest and easily absorbed.
This month’s sell-off, meanwhile, has been even more meagre:
Doing the rounds on Friday, though, is a rumour that might explain why some euro banks and portfolio managers could be more inclined to hold on to their dollars.
In a nutshell, they really need them.
Via IGM-FX on Friday:
Zerohedge has picked up on the talk and directs us to the Fed’s latest H.4.1 liquidity swap release.
The data shows how banks were forced to wean themselves off swap-line use in the run up to the facility’s expiry on February 1.
Interestingly there appears to have still been marginal use of the facility up until February 24.
We, of course, will have to wait until next week to find out if there’s been any re-newed action in the facility more recently.
But it’s interesting to note that the dollar’s mega surge higher against the euro did coincide with the run-up to the facility’s expiry in February:
Related links:
The dollar shortage problem, evaluated - FT Alphaville
Forex swaps forever! (or at least until October) - FT Alphaville
From turmoil to crisis: dislocations in the FX swap market before and after the failure of Lehman Brothers - BIS