NEW YORK, Oct 3 (Reuters) - The cost of raising short-term U.S. dollar funds in Japanese and European currency swap markets surged to more than two-y
NEW YORK, Oct 3 (Reuters) – The cost of raising
short-term U.S. dollar funds in Japanese and European currency
swap markets surged to more than two-year highs on Monday,
suggesting increased demand for the greenback as funding
pressure grew due to volatile financial markets characterized by
global central bank tightening.
The cross-currency basis swap, or relative premium for
swapping euro and yen for dollars, has widened since last week
due in part to year-end related demand for the U.S. currency to
square up corporate balance sheets, analysts said.
Dollar demand typically rises among corporates and asset
management firms as the end of the year approaches, with
portfolio rebalancing and fund transfers requiring currencies
like the euro and yen to be converted to the U.S. currency.
But that spread has remained elevated as investors grew
cautious about the global outlook.
The three-month euro cross rate hit -52.250 basis points
(bps) on Monday, the highest premium in favor of
the dollar since March 2020 just before the pandemic became
widespread.
The current euro swap rate meant that investors were willing
to pay more than 52 bps over interbank rates to swap three-month
euros into dollars.
The three-month yen swap rate was at -63.75,
the highest since March 2020 as well, while sterling three-month
swap rates were at -27 on Monday. Last Thursday,
that premium was at -28 basis points, the highest since March
2022.
“There’s a little more funding stress this year than in 2021
and 2020,” said Greg Anderson, global head of foreign exchange
strategy at BMO Capital Markets in New York.
He added that increased volatility from global tightening,
central bank interventions, and high inflation have contributed
to the stress.
Anderson pointed out that in 2020 and 2021 some investors
would have waited until Nov. 28 or 29 to exchange their
currencies for dollars to cover balance sheet needs, noting that
liquidity would not be a problem.
“But in this type of environment with wider credit spreads,
uneasy markets, and interventions all over the place, even
though it costs investors more, they covered that risk for three
months in September, instead of waiting and covering for one
month in November,” said Anderson.
“There is more of a desire to play it safe because the
liquidity may not be there when they need it.”
FX swaps allow investors to raise funds in a particular
currency, such as the dollar, from other funding currencies such
as the euro. For example, an institution which has dollar
funding needs can raise euros in euro funding markets and
convert the proceeds into dollar funding obligations via an FX
swap.
Since FX swaps are subject to counterparty and credit risks,
the pricing of these contracts is affected by perceptions of
creditworthiness of the banking system or external risks that
can affect liquidity, analysts said.
In the fixed income market, investors are keeping track of
U.S. front-end spreads on interest rate swaps tied to the
Secured Overnight Financing Rate (SOFR). Those spreads over
Treasuries have been volatile the last few weeks, and reflect
changing demand for U.S. government debt.
SOFR, the Libor replacement backed by the Federal Reserve,
is a broad measure of the cost of borrowing cash overnight,
collateralized by Treasury securities.
Last week, U.S. SOFR spreads on the front end narrowed,
suggesting declining demand for Treasuries among global central
banks as they seek to defend their currencies.
For instance, U.S. five-year SOFR swap spreads over
Treasuries tightened by about -27.3 basis
points (bps) last Tuesday, the narrowest margin ever since SOFR
spreads started trading in 2021.
On Monday, however, that spread has widened to -23.6 bps.
“There were more headlines around central banks selling
Treasuries to defend their currencies or at least broaching the
possibility given that the U.S. dollar has been so strong,” said
Dan Belton, fixed income strategist at BMO in Chicago.
Last week’s data from the Federal Reserve showed that
foreign official holdings of Treasury securities fell by $38
billion in par value terms last week. According to money market
research firm Wrightson, that was the largest weekly decline
since the early weeks of the pandemic.
(Reporting by Gertrude Chavez-Dreyfuss; Editing by Richard
Chang and Jonathan Oatis)
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