U.S. Markets

Fed's failure to fix credit plumbing leaves markets scrambling for dollars

TOKYO/HONG KONG (Reuters) - A global scramble for U.S. dollar financing worsened on Monday as the Federal Reserve’s aggressive move to flood markets with cash failed to temper borrowing costs and unclog funding for companies and banks hit by the coronavirus outbreak.

FILE PHOTO: U.S. currency is seen in this picture illustration taken March 6, 2020. REUTERS/Mike Segar/Illustration

The Fed slashed interest rates on Sunday, with central banks in New Zealand, Australia and Japan also cutting rates and pumping massive amounts of stimulus into battered markets. Other central banks also expanded stimulus last week.

But an absence of Fed measures to directly finance bank holdings of riskier corporate debt and the reluctance among multinational banks to go hat in hand to their central banks for dollar loans kept the cost of dollar funding elevated.

The Fed cut rates to near zero and expanded its balance sheet by buying at least $700 billion of Treasuries and mortgage-backed securities in the coming weeks.

The Fed and other major foreign central banks also cut pricing on their swap lines to make it easier for them to provide dollars to financial institutions around the world.

The announcement dragged U.S. bond yields down and pulled short-term dollar rates USD1MOIS= to near zero.

Yet, loans remained expensive in offshore markets, with Japanese banks paying a premium of 173 basis points to swap yen for one-month dollars JPYCBS1M=TKFX, almost a tenfold climb over the average price in the past year.

“In the long term, the moves will help to reduce dollar funding costs. If put in a desperate situation, people can rely on them,” said Takafumi Yamawaki, head of fixed income research at J.P. Morgan Securities.

“But unless turmoil in the stock market subsides, the dollar funding market will not stabilize. In the near term, markets are driven more by position unwinding,” he added.

The big disappointment for markets was that the Fed did not offer a repurchase program for the commercial paper market that companies use to raise short-term cash, as it had done in the aftermath of the 2008 crisis. Other measures to directly support credit markets were notably missing in Sunday’s announcement even though Fed Chairman Jerome Powell said the central bank wouldn’t hesitate to deploy them.

Flooding banks with cash at near-zero rates won’t help fix dislocations in credit markets caused by fear of lending to businesses with mounting losses, which in turn fuels distrust among banks, analysts said.

“Technically, if the Fed is firing the bazooka, there are a lot of dollars flushing around the system,” said a senior banking source in Singapore. “It’s just not going to the right company business use because it’s going into Treasuries.”

For the cash to flow into companies, the vicious cycle between falling confidence and demand needed to end, he said.

GRAPHIC: Funding stress in credit markets -


Meanwhile, senior bankers in Asia said major clients with supply chains and operations outside the region were worried about their cash flow being disrupted as countries close borders and economic activity grinds to a halt.

“Dollar liquidity is okay at the moment, but we obviously have to be careful and do a bit of rationing. There is a bit of flight to quality that is happening now,” said a senior corporate banker at a large regional bank.

Sources told Reuters banks are staying away or demanding higher pricing from companies in the travel, tourism and transportation sectors.

“A couple of cruise line companies are out in the market too and they are looking to raise a few million dollars,” said a trade banker at a European bank. “It would be very brave for someone to extend their balance sheet to them.”

Money market stress levels are still nowhere near what was seen at the height of the global financial crisis.

The spread between Libor rates LIBOR and the overnight indexed swap rate USD1MOIS= has widened to 60 basis points from 6 bps in a matter of 3 weeks. The spread, a widely used measure of banks' credit risks, was 5 times wider in 2008 and analysts expect it will narrow further after the Fed's move.

The cost of swapping euros for 3-month dollars rose more than 50 basis points on Friday to 72 basis points EURCBS3M=ICAP. It was above 300 bps in 2008.

Additional reporting by Anshuman Daga in Singapore; Writing by Vidya Ranganathan; Editing by Jacqueline Wong