Wednesday August 31, 2022 - 01:11:35 GMT
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Will There Be US Dollar Buying For Month End Rebalancing?
Have you ever heard of the term “month-end rebalancing?”
According to Investopedia, Rebalancing is the process of realigning the weightings of a portfolio of assets. Rebalancing involves periodically buying or selling assets in a portfolio to maintain an original or desired level of asset allocation or risk.
Many international equity managers like to minimize the forex exposure of their equity portfolio and put on forex hedges to reduce that risk. Thus, at the end of each month, they adjust the size of their hedges to bring them back into line with the current size of their portfolio.
For the forex trader, the focus is on whether forex hedges need to be reduced or increased. As a rule of thumb, if US stock prices increase during the month, short dollar hedges need to be increased (I.e. dollar selling) and vice versa if US equity prices fall during the month (I.e. dollar buying). Some adjust the hedges dynamically during the month and others do it on the last trading day of the month. Our focus is on the latter.
For example, say a foreign fund manager is long $1 mln worth of US stocks at the end of March and fully hedges the forex risk by being short the equivalent US dollars vs. his base currency (e.g. the euro). Stocks rise sharply by 10% during April and the stock portfolio is valued at $1,100,000. This leaves the fund manager under hedged by $100,000 so he has to sell that amount of dollars (e.g. vs. the euro) to fully hedge the forex risk. The same is true on the downside, meaning if stocks decline during the month then forex hedges need to be reduced (i.e. dollar buying).
Note, this is not an exact science so keep an eye on month-end flows as equities are lower on the month. A key time to watch is the 4 PM London fix.
There is another way to see whether there are month-end flows by getting access to and watching the trading lines formed by The Amazing Trader.
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