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Currency-Swap Spreads Signal Tighter Dollar Funding at Banks: Japan Credit

Yen currency-swap spreads expanded to the widest level since the collapse of Lehman Brothers Holdings Inc. froze credit markets in 2008, signaling that banks are facing tighter dollar funding.

Investors exchanging yen for dollars are accepting interest payments 54 basis points, or 0.54 percentage point, below the London Interbank-Offered Rate for the Japanese currency in a one-year swap, according to Bloomberg data, the lowest since October 2008. The premium European institutions are paying to get dollars was minus 48 basis points, the most since January. A negative level indicates investors will receive reduced interest on the yen and euro to obtain dollar financing.

Banks are charging each other the highest rates since April to borrow dollars after Europe’s sovereign-debt crisis spread beyond Greece and Standard & Poor’s removed its AAA rating on the U.S. The U.S. downgrade on Aug. 5 spurred speculation the value of assets linked to Treasuries will fall and hurt banks’ balance sheets, according to Tokuyoshi Takano, a derivatives manager in Tokyo at Mitsui Sumitomo Insurance Co.

“The move of the swaps shows credit shortage,” said Takano, whose company manages the equivalent of $70 billion in assets. “Though there is demand for dollar funding, banks are wary about their counterparts’ credit risk and refrain from trading. They’ve become very cautious since the Lehman shock.”

Bank of Japan Governor Masaaki Shirakawa said last week that the central bank may provide banks with foreign currencies should domestic financial companies face difficulty in funding.

Bank Debt

The cost to protect against a default by U.S. banks rose and a benchmark gauge of corporate credit risk reached a 14- month high amid concern that Europe’s debt crisis will infect the global financial system.

Credit-default swaps on Bank of America Corp., the biggest U.S. lender, surged to the highest since April 2009 last week before paring the gain. France, Spain, Italy and Belgium imposed bans on short-selling on Aug. 12 after the rout of European financial shares. Regulators imposed similar limits on short sales in September 2008.

Cross-currency basis swaps, which usually range from one to 30 years, are agreements in which an investor borrows in one currency and simultaneously lends in another. The trade involves the exchange of two different floating-rate payments, each denominated in a separate currency and based on a different index.

The swap spreads show “few are willing to be a counterparty for European banks for dollar funding,” said Makoto Noji, a senior bond and currency strategist in Tokyo at SMBC Nikko Securities Inc., a unit of Japan’s second-biggest lender by market value.

Counterparty Risk

Credit-default swaps for France’s debt, used to speculate on credit quality, reached 174 basis points on Aug. 10, the highest level in at least six years, according to data provider CMA, which is owned by CME Group Inc. and compiles prices in the privately negotiated market. A gain in price signals deteriorating perceptions of creditworthiness.

S&P, Moody’s Investors Service and Fitch Ratings have separately affirmed France’s top credit ratings amid concern the country’s creditworthiness was in doubt.

Three-month Libor for dollar loans advanced to 0.29006 percent on Aug. 12, a level not seen since April 6. The rate for the yen dropped to 0.19313 percent, the least since March 14, after Japan sold its currency on Aug. 4 to halt the yen’s climb toward record levels, the third such intervention in the past 12 months.

Fed Action

The rising dollar Libor indicates “the market is gradually pricing in counterparty risks,” said Ayako Sera, a market strategist at Sumitomo Trust & Banking Co., which manages the equivalent of $317 billion in Tokyo. “It wouldn’t be a surprise if the Fed takes action to protect the banking system.”

Federal Reserve Chairman Ben S. Bernanke signaled last week he may expand record monetary stimulus to revive the faltering recovery. The Fed said on Aug. 9 that officials “discussed the range of policy tools” to strengthen growth and pledged to keep its benchmark interest rate near zero until at least mid-2013.

The yield spread between two-year U.S. notes and the Japanese equivalent fell to 3.4 basis points today, set for the least since 1992. Two-year Treasury yields slid to a record low after the Fed’s announcement.

Yen Intervention

Yields on Japan’s benchmark 10-year bonds fell half a basis point to 1.035 percent today after touching 0.975 percent on Aug. 9, the least since November.

The nation’s first intervention in foreign-exchange markets since March may have contributed to the tightening of dollar credit relative to the yen, according to Reiko Tokukatsu, a senior fixed-income strategist at Barclays Capital Japan Ltd.

The intervention amount was probably a record 4.5 trillion yen ($58 billion) based on changes in deposits at the Bank of Japan held by financial companies, according to Yuichi Takahashi, a market economist at Totan Research Co. in Tokyo.

“The BOJ’s large-scale currency intervention to sell the yen and buy up dollars has tightened funding of the U.S. currency, widening the swap premium,” Tokukatsu said.

The yen traded as strong as 76.30 per dollar on Aug. 1, approaching the postwar high of 76.25 reached on March 17 that prompted coordinated intervention by Group of Seven nations a day later. It traded at 76.93 as of 10:43 a.m. in Tokyo.

To contact the reporters on this story: Saburo Funabiki in Tokyo at sfunabiki@bloomberg.net; Masaki Kondo in Singapore at mkondo3@bloomberg.net

To contact the editor responsible for this story: Rocky Swift at rswift5@bloomberg.net

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