Offshore dollar funding markets flash amber as squeeze intensifies

LONDON (Reuters) – Investors rushed to secure dollar funding lines via the currency derivative markets on Tuesday, in a sign central bank stimulus is not easing growing pressure in money markets.

Unlike the 2008 crisis when banks were at the epicentre, analysts say the dollar funding squeeze of 2020 is probably driven by lenders hoarding the U.S. currency in anticipation of greater liquidity needs from companies and growing worries about loan defaults.

The pressure showed up in euro/dollar three-month FX swap spreads, which blew out briefly to 124 bps, the widest since the euro zone debt crisis in late 2011 when European banks found themselves shut out of global money markets.

A wider spread indicates market participants are willing to pay a higher premium for dollars. That spread was up from less than 90 on Monday and compared to 20 bps in early March.

“What it tells you is that somebody is deeply deleveraging and is in real need of dollars,” said Sebastian Galy, a senior macro strategist at Nordea Asset Management.

“There is blood on the street we just don’t know where it is.”

(GRAPHIC: CCY basis swap – here)

A coordinated round of rate cuts, led by a 100 basis point cut by the U.S. Federal Reserve and billions of dollars in liquidity injections over the weekend, has failed to reduce the nervousness in money markets and analysts expect more policy action.

Some of the biggest banks in the United States said overnight they would access the Fed’s discount window.

Pressures were also seen in the pound/dollar GBPCBS3M=ICAP swap markets where spreads ballooned out to 90 bps, the widest since December 2008.

The dollar/yen basis swap – the premium investors pay over interbank rates to swap yen into 3-month dollars – eased to 91 basis points JPYCBS3M=TKFX from a high of 142 basis points on Monday.

Yen swaps stepped back from their widest levels after the Japanese central bank pumped $30 billion into markets with an 84-day dollar funding operation, its biggest since late 2008.

Money markets are crucial for the smooth functioning of global markets and economies as investors and companies rely on them for their daily funding requirements.

For an explainer on how these markets and FX swaps work.

FRA-OIS spreads <0#USDFWDF-O=R>, which measure the difference between term lending and overnight rates and are a gauge of the risk banks attach to lending to each other, also eased but only fractionally.