How month-end rebalancing works

Author: Adam Button | Category: Education

How month-end models can predict movements into the end-of-month fix

How month-end models can predict movements into the end-of-month fix
Here is how SocGen explains its month-end currency rebalancing model and it's a good basis for how all firms try to anticipate what will happen into the month-end fix.

The FX Month-End Rebalancing model explained The model is based on the concept that global portfolio managers have set benchmarks for currency hedge ratios and, as the value of their assets within their portfolio changes over the course of the month, portfolio managers will need to re-hedge their currency exposure, so that their currency benchmarks are maintained. Typically, these FX rebalancing flows are seen at the end of the month and usually their impact is felt most near the 4pm London fix on the last trading day of the month.

We look at the change in equity performance by market capitalisation for all G10 currencies. and we adjust this for monthly FX spot moves. This provides an indication of how the value of assets has changed over the course of the month and thus the extent of portfolio rebalancing flows that will likely take place at the end of the month. We generate a signal for all USD"10 currency pairs indicating the expected direction and strength of FX month-end flows. The strength of the signal is dependent on the size of equity/FX moves over the course of the month, relative to previous history (from 2002). The signal is on a scale from +5 to -5. A signal of +5 indicates month-end flows are expected to be strongly USD/CCY positive, while -5 indicates flows are projected to be strongly USDICCY negative.
In my experience, these models are tough to profit from except for a very short period around the fix at the end of the month but at times during period of high volatility and large divergences in global assets, they can be valuable.

h/t @bovell_GM - Nick Bovell

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