March 12, 2020 / 2:35 PM / 20 days ago

UPDATE 2-Dollar swaps blow out in sign of mounting funding stresses

(Adds U.S. high yield, Libor-OIS)

By Saikat Chatterjee and Sujata Rao

LONDON, March 12 (Reuters) - Demand for dollars via the currency derivative market surged to the highest levels in years on Thursday in a sign that coronavirus-induced economic stress is starting to manifest itself in a broad scramble for greenback funding.

In a eerie throwback to the dark days of the 2008 financial crisis when banks rushed to secure dollar funding amid a credit market seize-up, spreads on three-month euro-dollar and dollar-yen swap spreads were at their widest since 2017.

A widening spread indicates that non-U.S. borrowers are prepared to pay a premium to access dollar funds, and further such strains on swap markets could pressure the U.S. Federal Reserve to up liquidity operations such as repos and swap lines.

"Dollar liquidity is king in times of crisis and that is what the blow-out in swap spreads is telling us," said Kenneth Broux, a currency strategist at Societe Generale in London.

He said this could mark a move into the next sell-off stage, which could mean a three-week long worldwide rout in shares and riskier bonds giving way to a rush for dollars.

The surge caught market participants by surprise and helped the dollar reverse earlier losses in the spot market. It rose 1% against a basket of currencies, rebounding from 18-month lows hit earlier this week.

Three-month euro/dollar cross currency basis swap spreads jumped to a late-2017 high of 65 bps. Spreads widened by nearly 40 bps on Thursday, the biggest single-day rise since December 2008.

Moves were even bigger in yen swap spreads, where three-month spreads were at their highest since December 2017 at 89 bps, double Wednesday's closing levels.

Euro-dollar swaps had widened as much as 160 bps during the European debt crisis in 2011/12 and the 2008/09 meltdown, and most analysts agree that global liquidity is far less constrained these days.

But signs are that companies, especially in the travel, leisure and retail industries which are hardest hit by the coronavirus-induced slump, may face trouble with cashflow or repaying debt which they took out during the boom years.

Stuart Oakley, a strategist at Nomura in Singapore, said companies may be acting on the premise that more countries could emulate Italy-style lockdowns has to contain the virus spread.

"So what people normally try and do is scramble to get their hands on dollars – borrow dollars – just so they're liquid, they’ve got cash on the hip for when they need it," Oakley added.

US FRA-OIS spread, a measure of future bank borrowing costs, widened to 64 basis points, the widest since at least 2011.


Reuters reported on Wednesday that Boeing Co was planning to draw down the rest of a $13.8 billion loan agreed last month. Fears are many other firms will try to do the same.

The worries are reflected also in the soaring cost of insuring against default by companies and banks in the credit default swap market - a CDS index of sub-investment grade European companies hit the highest since November.

The Markit high-yield credit-default swap index - widely used as a gauge of sentiment about high-yield debt - surged to its highest since November 2011. "The meltdown in the real economy is severe enough that it could push banks to the limit and that's what the cross currency basis is telling us," said Stephen Gallo, European head of FX markets at BMO Financial Group.

In an effort to stem the damage, major central banks have embarked on a policy easing spree in recent days, though analysts remained divided on the impact of the easing.

The Federal Reserve Bank of New York said on Thursday that it will introduce new repo operations and start purchasing a range of maturities as part of it's monthly Treasury purchases.

It said changes to its bill-buying were made to address highly unusual disruptions in treasury financing markets associated with virus.

The U.S. Federal Reserve cut interest rates by 50 bps last week. The Bank of England on Wednesday followed with a similar move, and the European Central Bank approved fresh policy easing measures.

The New York Federal Reserve announced on Wednesday, the second time this week, it would substantially increase the liquidity it provides to overnight lending market - a signal it would do what it could to keep money markets running smoothly.

Reporting by Saikat Chatterjee and Sujata Rao; additional reporting by Kate Duguid and Megan Davies; Editing by Giles Elgood and Richard Chang

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