Cash in as funds move to balance fx hedging

AS September rolls around, so does the opportunity to take advantage of currency movements as hedge funds and portfolio managers move to rebalance their currency exposure at the end of the month.

The greater the swing in principal asset prices, primarily those of equities and bonds, the more likely it is that fund managers are going to be over or under exposed to certain currencies.

During months that equity markets endure a net monthly decline, currency managers tend to be left over-hedged on their offshore equity exposure. As a result, portfolio and hedge fund managers will move to reduce their currency hedge requirements.

If this monthly decline has been large enough, adjustments in ratios can generate a sizeable intra-day dip. Sizeable declines in the MSCI world index in the last month seem to suggest that we are heading in this direction. At one point the index had dropped by 14.2 per cent.

DOLLAR DEFICIENCIES
According to Kathleen Brooks, research director for Forex.com, we started to see the effects of portfolios being over-hedged yesterday, where funds were short dollar and needed to buy dollars to rebalance their portfolios. The dollar strengthened across the board, with euro-dollar moving from $1.4533 to $1.4380. “This is a bit like a ‘synthetic’ appreciation of the dollar,” says Brooks. “Once the month-end flows stop later in the week, we could see a reversal.”

AIMING FOR THE ANTIPODES
Besides the euro-dollar pair, many analysts are setting their sights on the Australian dollar-dollar for an end-of-month dip. Pointing to the 8.2 per cent net decline in the MSCI, Richard Grace, chief currency strategist for the Commonwealth Bank of Australia, predicts a proportional move from currency hedgers. “It is likely that the size of the monthly currency hedge adjustment that corresponds to an approximate 8.2 per cent decline in the global equity market will generate an end-of-month dip in Australian dollar-dollar of up to 1.5 per cent.”

With the Australian dollar hovering around the $1.069 mark, traders should look today for dips to the $1.0500 mark to buy in.

Traders should be aware, however, of the short term nature of this strategy. While Australian dollar-dollar looks set to hit $1.0800 by the end of the week, Alejandro Zambrano, market strategist for FXCM, warns that fundamentals could come into play once the end-of-month dip has played out. “The survival of this setup will not depend on the technical outlook, but rather the outcome of the US ISM non-manufacturing survey tomorrow and the US non-farm payrolls report on Friday.” Zambrano adds: “If any of these reports do not hit the mark, traders will be exiting their long positions before we reach either $1.04 or $1.08.”