Foreign Exchange Fixings and Returns Around the Clock

We document a new empirical finding in the foreign exchange market: currency returns show long and significant intraday drifts that reverse strongly at specific points during the day. These reversals align with the times of the three major institutional benchmark fixings, when reference rates are published. These rates are used regularly in executing trades, hedging decisions and valuating portfolios.

Using data from a major inter-dealer platform, we show there is a predictable and significant appreciation of the US dollar in the hours before the fixes and a depreciation after the fixes. Intraday price reversals are explained by imbalances in the orders in the FX spot market before fixes. We show that these reversals are, on average, tilted toward a demand for US dollars. We also highlight that imbalances in the order flow from trading desks of large banks play a larger role for intraday price drifts than flows from speculators or hedgers. Thus, our results show that a combination of a variety of market participants having different trading motives is crucial in the fragmented FX market.

We propose that this intraday pattern can be explained by:

• transaction demands by clients who are located in different time zones
• inventory management by dealer banks who provide immediacy to their clients around the clock.

As buyers and sellers arrive at different times in the over-the-counter FX market, brief imbalances between clients' buy and sell volumes arise in the hours before the fixes. These are absorbed by a small number of large dealer banks that act as intermediaries. They warehouse much of the inventory risk arising from the pre-fix imbalances and enter into currency hedges to reduce the risk of the uncertain amount of client orders—thus pushing up the price of the US dollar. After the fix, they trade away order imbalances by transacting with counterparties arriving later in the day.