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USD Buying on Fed Balance Sheet Unwind may be Mired by Month-End FX Rebalancing

USD Buying on Fed Balance Sheet Unwind may be Mired by Month-End FX Rebalancing

2018-08-31 08:00:00
Justin McQueen, Analyst
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USD Analysis and Talking Points

  • Federal Reserve Balance Sheet Unwind to Lead to Net Negative Liquidity Impact of 11.4bln
  • USD Typically Bid on Redemption Days

See our Q3 FX forecast to learn what will drive major currencies throughout the quarter.

Federal Reserve Balance Sheet Unwind

Last year the Federal Reserve announce that they would slowly begin to shrink the Federal Reserve balance sheet from October, starting at a rate of $6bln/month and working up to a maximum of $50bln, in order to unload the $4.5tln of bonds acquired by the central bank through its QE program.The Fed has been rolling over its holdings of debt on expiry date, however it is now in the process of letting the debt roll of its balance sheet and redeeming the full amount paid for the bonds, creating a demand for Dollars in the process.

Short term Impact on the USD

Typically, on days with a large and negative impact USD liquidity, the Dollar has tended to gain while risk sentiment has been softer. Today marks the next redemption day in which the shrinking Fed balance sheet will lead to a net negative impact on US liquidity by around $11.4bln.

Dates

Par Value

Daily Impact on US Liquidity

Monthly Cap

USD Performance

Oct 31st 2017

$8.7bln

-$6bln

$6bln

0%

Nov 15th 2017

$11bln

-$3.5bln

$6bln

0%

Nov 30th 2017

$7.9bln

-$2.5bln

$6bln

-0.1%

Dec 31st 2017

$17.5bln

-$6bln

$6bln

0.1%

Jan 31st 2018

$27.6bln

-$12bln

$12bln

0%

Feb 15th 2018

$16.6bln

-$4.1bln

$12bln

-0.6%

Feb 28th 2018

$32bln

-$7.9bln

$12bln

0.3%

Mar 31st 2018

$31.2bln

-$12bln

$12bln

0.1%

Apr 30th 2018

$30.4bln

-$18bln

$18bln

0.3%

May 15th 2018

$26.2bln

-$8.6bln

$18bln

0.7%

May 31st 2018

$28.5bln

-$9.4bln

$18bln

-0.1%

Jun 30th 2018

$30.5bln

-$18bln

$18bln

0.4%

Jul 31st 2018

$28.5bln

-$24bln

$24bln

0.5%

Aug 15th 2018

$23.1bln

-$12.6bln

$24bln

0.0%

Aug 31st 2018

$20.9bln

-$11.4bln

$24bln

Source: Federal Reserve

Long USD on SOMA Days

Based on the past 5 SOMA redemption days, long USD has been a good proposition, given that these days have on average coincided with the Dollar index moving higher by 0.3% with a hit ratio above 70%. Consequently, this could see the USD firm against its major counterparts for much of the session.

Month End Rebalancing May Complicate USD Demand

Demand for buying the USD on Fed redemption day could be complicated by month-end FX rebalancing, in which, investment bank models suggest strong USD selling against all peers, most notably the Euro, GBP and AUD.

US Dollar Price Chart: Daily Time Frame (July-August 2018)

USD Buying on Fed Balance Sheet Unwind may be Mired by Month-End FX Rebalancing

Provided the USD follows the typical price action of rising 0.3% on Fed balance sheet redemption day, the USD could push towards 94.50. However, if indeed month-end FX rebalancing dominates FX flow then a break through 94 may open up a move to 93.75.

USD TRADING RESOURCES:

--- Written by Justin McQueen, Market Analyst

To contact Justin, email him at Justin.mcqueen@ig.com

Follow Justin on Twitter @JMcQueenFX

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