Borrowing costs for US dollars in currency derivatives markets went up on Monday to their highest level in nearly a year, driven by the year-end dollar funding rush and the euro's downward slide against the dollar.
Spreads on three-month euro-dollar cross-currency basis swaps were at the widest since December 2020, at around minus 27 basis points, implying that non-U. S. borrowers are prepared to pay a premium to access dollar funding.
A cross-currency basis swap CCBS sees parties exchange interest rate payments in two different currencies and is often used by traders swapping liabilities to the desired currency.
Corporates and asset management firms generally step up dollar buying as the end of the year approaches, with portfolio rebalancing and fund transfers requiring currency like the euro and sterling to be converted to the U.S. currency.
Since December, spreads on yen-dollar swaps were the widest since, although sterling-dollar spreads were more resilient at minus 16.5 bps, a two week high Typically we see demand for dollar funding increase towards year end, especially among Asian borrowers who have large dollar-denominated liabilities, Valentin Marinov, head of G 10 FX research at Credit Agricole said noting similar pressures last year and in 2019.
The dollar has risen recently due to economic data showing the U.S Federal Reserve possibly tightening policy earlier in the day and stepping up the pace of the unwind.
The dollar is trading just off 16 month highs against a basket of its rivals. It's been up nearly 2.5% against the euro so far this month.
One trader said that the euro's decline over the past few days may have contributed to the widening spreads.
The European Central Bank has pushed back against markets pricing a rate rise next year, and those expectations have been dialled down further by the resurgence of COVID 19 cases across the continent.
The ECB increased the upper limit of cash as collateral for the euro securities lending programme to 150 billion euros from 75 billion euros last week, easing the demand for cash euros.
Stephen Gallo, chief European FX strategist at BMO Capital Markets, cautioned that a widening of credit spreads for European borrowers could boost dollar funding costs in the coming month, as did Stephen Gallo, chief European FX strategist at BMO Capital Markets.
Gallo said we have that as a potential scenario for the euro next year, even though he described that outcome as an outlier.