Tactically Bearish USD/JPY, Risk of Reversal
- FX Volatility to Stay Elevated Given Month/Quarter End Rebalancing
- USD Upside Momentum Stretched
- Tactically Bearish USD/JPY
Today is month and quarter-end rebalancing, which I suspect has played a part in exacerbating some of this USD strength we have seen in recent sessions. The S&P 500 is on course to post its worst monthly performance since September 2020 (-3.6%) and generally, when we have seen a negative monthly performance in the index, the greenback has tended to pick up in the final week.
Below is a quick explainer on the London fix and the month-end fix….
London WMR Fix (1600 London Time): The WMR Fix is one of the most widely used benchmarks for FX trading, taking place every day within a 5-minute window around 1600 London time. The fix provides a standard set of currency benchmark rates so that equity and bond investors can compare portfolio valuations and performance with each other.
The WMR fix tends to coincide with a sharp rise in trading volume, prompting a sizeable increase in liquidity. Occasionally, this allows for large real money flows to take place without causing too many distortions. However, flows can also be dominant in one direction (strong buying or strong selling) leading to outsized moves in a very short period of time.
The largest bout of volatility stems from the month-end fix, taking place on the last business, where market extreme moves can often occur in the lead up during 15:00-16:00 London Time. These FX flows are derived from mostly equity rebalancing.
As such, if a UK portfolio manager holds US Dollar-denominated assets and seeks to hedge FX risk, then a monthly rise in the value of those assets will lead to more dollar hedging (selling the dollar). For example, if equities are FX hedged and US stocks (S&P 500) have risen on the month, while the FTSE 100 (UK stock market) has traded flat, then UK based investors would sell US Dollars against the Pound to add to their hedge, leading to an appreciation in GBP/USD. The greater the outperformance of the US equity market over the UK would be associated with greater selling of the USD against GBP, prompting GBP to rise even higher. Although, extreme moves can often partially revert in the day following the month-end fix. That said, the occurrence of such an event in a market as liquid as FX, suggests that the London fix (month-end fix in particular) is important for FX traders to watch for.
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Taking a look at the USD, it appears there has been a slight pick in the greenback heading into the European cash equity open, which does raise my suspicion into whether this is front-running month-end rebalancing.
Source: Refinitiv, DailyFX
That said, given how stretched USD momentum is on the topside, I am tactically bearish, looking for a mean reversion after the London 4pm fix against the Japanese Yen. An interesting observation this year in USD/JPY has been a reversal after a ramp higher into quarter end as the chart below shows. To add to this, as I have said many times before, US yields will also be important to watch for the direction in the Japanese Yen.
USD/JPY Ramp and Reversal Around Quarter End
On the technical front, the Covid peak resides at 112.20, while the RSI is not only moving into overbought territory, but also starting to show a bearish RSI divergence, which limits the reward for chasing USD/JPY higher in the short-run.
USD/JPY Chart: Daily Time Frame