November 9, 2012 / 11:51 AM / in 5 years

FX COLUMN-Fiscal cliff impact may hobble hedge fund FX flows

--Neal Kimberley is an FX market analyst for Reuters. The opinions expressed are his own--

By Neal Kimberley

LONDON, Nov 9 (Reuters) - Among those peering most anxiously over the U.S. “fiscal cliff” are arguably hedge fund foreign exchange sales traders and their banks.

The implications of possible U.S. tax hikes for hedge fund FX volumes and, by extension, profitability in early 2013 are not pretty. There are implications for the wider market too.

Hedge fund flows are highly prized by banks given that their size can potentially move the wider foreign exchange market.

Investors with capital gains on hedge fund investments may be considering crystallising their profits before year-end, given the chance U.S. tax rates will rise on Dec. 31 if the White House and Congress fail to agree a compromise.

To fund those redemptions, U.S. hedge funds, many of which close their books in November anyway, would probably adjust their positions to ensure they had enough cash.

Given that investors have to give notice of redemption perhaps three months in advance, any such a djustment m ay already have largely occurred.

That might explain some of the dollar index’s strength as U.S. hedge funds would repay investors in that currency.

That said, hedge fund sales traders might still expect their clients to be net buyers of dollars until the books are closed.

Unfortunately for those bank hedge fund sales desks that may be as good as it gets.

If investors in hedge funds do lock in gains, those funds might limit their risk-taking in early 2013 until they have greater clarity on whether clients will re-invest.

Following the U.S. elections, U.S. financial advisers are focusing on lowering their clients’ tax bills.

Conventional wisdom that people should defer taxes whenever possible may be academic now that the elections have killed what little hope the U.S. wealthy had for avoiding higher taxes next year.

Some have already decided that this is the right time to take profits on their invested time and investments.

If that were to mean a muted start to 2013 in FX trading by the hedge fund community, that would put a real dampener on the prospects for those bank sales desks covering that segment of market. (Editing by Nigel Stephenson)

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