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Dollar funding pressures heat up in FX swaps
August 11, 2011 / 9:23 AM / 6 years ago

Dollar funding pressures heat up in FX swaps

HONG KONG (Reuters) - European banks sought to secure dollar funding beyond one week in the currency derivatives market on Thursday, pushing one gauge of funding costs to the highest levels since the 2008 crisis as major financial institutions cut back exposure to the problem-plagued euro zone.

Signs of investors and banks hoarding funds to protect themselves from further market volatility were widespread, with negative short-term rates in Singapore and Switzerland underscoring the rush into markets considered the safest of havens.

One senior trader at a major European bank in Singapore said his desk has curtailed lending to a few other European banks beyond a few days or a week, mirroring moves by others.

In response, some European banks have turned to the foreign exchange market, particularly FX forwards and swaps, to obtain dollar funding as counterparties have clammed up. Those banks needing dollars have had little trouble tapping the FX markets so far, traders said.

European banks are in the spotlight as the raging euro zone crisis took an ugly twist on Wednesday, with a variety of rumors sparking a sharp selloff in French bank shares and sharp widening of French sovereign CDS spreads that hit U.S. and Asian shares as well.

“There is no denying that accessing funds is hard for certain European names. But we are very far away from the panic times of 2008,” said one fixed-income trader at a Japanese securities house in Hong Kong.

The one-year yen-dollar cross-currency basis -- which reflects the premium for swapping yen LIBOR into dollar LIBOR -- extended its rise to 56 basis points briefly, the highest since November 2008. The temporary Thursday level was up 20 bps in a little more than a week and approaching a peak of 77 bps reached during the financial crisis.

“Though we have tools like the Fed’s swap lines and massive dollar deposits by some of these European banks sitting offshore, things are quite nervous out there,” the fixed-income trader said.

The three-month spread on euro-dollar cross FX swap held around 88 bps in early European trade after having more than doubled in the past two weeks.

Steven Walsh, chief investment officer at Western Asset Management, expects more market volatility and systemic stress ahead because it will take years for euro zone countries to stabilize their debt.

Europe has planned a stability fund, the EPSF, but it’s not operational. Walsh said it will need to be enlarged to at least 1 trillion euros -- from around 440 billion euros -- to help put out Europe’s flames, but it will take a worsening of the crisis before that will happen.


The rush for safety has spilled into Singapore and led to the city-state following the United States and Switzerland where short-term interest rates have turned negative, implying that depositors are willing to pay to keep funds at banks or in short-term bills.

Singapore’s swap offer rate (SOR) -- a rate determined by both local deposit rates and FX forwards -- was set in negative territory for the second day on Thursday as funds seeking safety flooded the local market with cash. The six-month SOR was fixed in negative territory for the first time ever on Wednesday.

On Thursday, three and six month rates were fixed at minus 0.69870 and minus 0.99258 percent respectively.

“In the current climate of the U.S. keeping rates low for an extended period of time, and given the MAS’s FX appreciation bias, we believe the likely outcome will be sustained low fixes and, in the near term, negative fixes,” said analysts at Nomura in a note to clients.

The Singapore central bank’s resolve to allow more currency appreciation and deter capital inflows -- on top of funds rushing into what’s seen as the safest bond market in Asia -- have all led to the rare occurrence of negative interest rates.

Asian equity markets were holding up well, thanks in part to a rebound in S&P futures during the day that limited the slide. Bourses in South Korea's KOSPI .KS11 and the Shanghai Composite .SSEC were in positive territory.

The trouble has spilled from Europe where benchmark EURIBOR interbank lending rates have risen sharply over overnight index swaps -- a sign that banks are becoming unwilling to lend to each other.

In a sign that conditions are deteriorating within Europe, the EURIBOR-OIS spread has blown out to over 70 bps this week and has doubled in the past two weeks to the widest in two years. The LIBOR-OIS spread has also widened to one-year highs but remains relatively subdued at 22 bps.

Countries in Asia showed signs of taking measures to protect their local markets against further turbulence from Europe and the United States.

Indonesia’s central bank launched a facility to provide dollar funding to banks by swapping U.S. dollars in its FX reserves for local government bonds.

While Asian stock markets have taken a hit in the global selloff, local bond and currency markets have remained stable. Foreign investors have showed few signs of pulling funds out of Asia.

The Philippines central bank said it was talking to local banks about limiting hot money inflows via offshore currency forwards.

If anything, investors have preferred to keep funds invested in Asia rather than elsewhere given the region’s stronger fiscal health and economic growth.

But the market shocks have caused a dramatic reassessment of the policy outlook for central banks that had been jacking up rates to combat Asia’s stronger inflation pressures.

South Korea’s central bank kept rates on hold on Thursday, while short-term rates in Australia and India have plunged on expectations that policy could switch gears toward cutting rates.

Additional reporting by Masayuki Kitano, Swati Bhat and Kit Yin Boey in Singapore; Editing by Eric Burroughs and Richard Borsuk

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