The Year-End Turn in FX Forwards
Forward points that span a year-end often trade at distorted levels because banks shrink their balance sheets right at reporting dates, temporarily making short-term funding scarce and expensive.
Prerequisites: FX-Swap-Implied Yields and Synthetic Funding
Forward points for FX swaps and forwards that happen to span December 31st routinely trade at levels that look nothing like the smooth interpolation of every other maturity around them. This is the year-end turn: banks deliberately shrink their balance sheets right at fiscal year-end to improve the regulatory ratios they report to supervisors, and a smaller balance sheet means less capacity to warehouse short-term FX swap positions across that date.
Because fewer banks are willing to provide funding across the turn, whoever still needs dollars (or another currency) spanning December 31st has to pay up for it, and that scarcity shows up directly as an anomalous jump in forward points for exactly the tenors that straddle year-end — while tenors just a few days shorter or longer look normal.
The year-end turn is a predictable, recurring distortion in FX forward points caused by banks' balance-sheet window-dressing at fiscal year-end, not by any change in genuine interest-rate expectations.
Worked example
Suppose one-week forward points are stable at roughly 2 pips per day of tenor for every week in November. The one week spanning December 25–January 1, however, prices at 40 pips instead of the expected 14, because dozens of banks are simultaneously unwilling to lend dollars across their own reporting date. A desk needing dollar funding across the turn either pays that premium, arranges funding to avoid straddling year-end entirely, or accepts the cost as a known, seasonal, and largely unavoidable feature of the funding market rather than a mispricing to arbitrage away.
Further reading
- BIS Quarterly Review, 'The Dollar-Trillion FX Swap Market'