The premium that European lenders pay to obtain dollar-denominated cash flows increased for a seventh day as global central banks said they’ll wind down emergency funding programs.
The rate on a three-month cross-currency basis swap between euros and dollars was negative four basis points, after reaching positive 4.8 basis points Jan. 16. A negative swap rate signals traders are paying a premium to trade euro-based cash flows for comparable flows denominated in U.S. dollars. Investor demand for safety increased amid a deepening selloff in emerging-market currencies.
“The realization is settling in that there are still a lot of potential surprises out there, including those in the liquidity mechanisms and with respect to spillover effects from market to market,” Jeffrey Caughron, who advises community banks on investments exceeding $40 billion as an associate partner at Baker Group LP in Oklahoma City, said in a telephone interview. “We are certainly a lot healthier than we were in 2008 and 2009, no doubt about that. But that doesn’t mean that we are out of the woods.”
The European Central Bank and global peers will phase out emergency dollar liquidity facilities that have helped lenders weather financial turbulence since 2007. Support from global central banks during the financial crisis helped funding swaps return from levels that reached negative 210 basis points in October 2008.
“In view of the considerable improvement in U.S. dollar funding conditions and the low demand for U.S. dollar liquidity-providing operations,” the ECB, the Bank of England, the Bank of Japan and the Swiss National Bank jointly decided to reduce the offering of dollar loans to banks, the Frankfurt-based ECB said in a statement today.
The ECB will cease to conduct three-month U.S. dollar liquidity operations in April. It will conduct one-week U.S. dollar tenders at least until July 31 and will assess the need for further one-week dollar operations after July.
Demand for alternative dollar funding methods, such as through the currency derivative markets that include cross-currency basis swaps, eased after the U.S. Federal Reserve allowed the world’s largest central banks to offer unlimited dollar loans in October 2008 through currency swap lines.
As government reforms and an ECB bond-buying plan in 2012 eased Europe’s debt crisis, permanent swap facilities between central banks were established to allow easy access to emergency cash if required even if standing tenders are wound down. These swap lines remain in place.
“Recently established standing swap lines provide a framework for the reintroduction of US dollar liquidity-providing operations if warranted by market conditions,” the ECB said in today’s statement.
Emerging-market currencies slid as anti-government protests in Ukraine and Thailand and a corruption investigation in Turkey involving Prime Minister Recep Tayyip Erdogan’s cabinet undermined investors’ confidence in the political stability of the countries.
The Turkish lira plunged to a record and South Africa’s rand fell yesterday to a level weaker than 11 per dollar for the first time since 2008. The declines were part of a broader slide in global markets, with European stocks falling, U.S. stocks lower and Asian shares tumbling. Yields on 10-year German bunds and U.S. Treasuries dropped for a second day, reaching 1.64 percent and 2.70 percent.
The high-risk currencies also tumbled amid speculation that negative fallout from the Fed’s tapering of monetary stimulus will hurt them. The U.S. central bank cut monthly bond purchases to $75 billion in January, from $85 billion, and said it will consider further reductions if the economy improves.
“The actual policy change the Fed made, with the tapering, was so slight and so minor that it shouldn’t really have any meaningful effect,” Baker Group’s Caughron said. “But the perception is ‘Oh, God, the Fed is pulling out and we could potentially be back dealing with the same kind of problems we were in 2008-09.’”
Cross-currency basis swaps, which usually range from one to 30 years, are agreements in which a person 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.
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