European Banks' Dollar Swap Costs Jump to Highest Since 2012

  • Derivatives add to Deutsche Bank's bullish view of dollar
  • Futures show 66% probability of Fed rate increase in December

Another ripple in the derivatives market is emerging as the Federal Reserve’s Open Market Committee moves closer to raising interest rates for the first time since the financial crisis.

The cost for European banks to fund in dollars for one year rose to the highest level in three years on Wednesday, adding to pressures that could send the U.S. currency closer to parity against euro, according to Deutsche Bank AG, the world’s second-largest foreign-exchange trader. The probability that the Fed will raise rates by next month is 66 percent, compared with 50 percent at the end of October, futures contracts indicate.

“A new dollar-supportive driver is emerging beyond the widely understood central bank divergence story: the rising cost of dollar funding,” George Saravelos, global co-head of foreign exchange research at Deutsche Bank in London, wrote in an e-mailed note. “A combination of year-end funding constraints, lack of liquidity, regulatory pressure and precautionary demand for dollars ahead of FOMC lift-off seem to all be driving the move in the basis. This adds to the bullish dollar view.”

The one-year cross-currency basis swap rate between euros and dollars reached negative 39 basis points Wednesday, the largest effective premium for dollar borrowing in swaps since September 2012, according to data compiled by Bloomberg. The euro spot rate was little changed at $1.0720 as of 12:41 p.m. London time, after dropping to $1.0675 on Tuesday, the weakest since April 23.