Currency Hedging Bulges Thanks to ‘Flight From Zero,’ BIS Says

  • Demand is driven by investors, companies seeking better rates
  • Japanese life insurers among those seeking dollar assets: BIS

The ripple effects of global monetary easing just keep on coming.

Demand for currency hedging is increasing, indirectly spurred by a handful of central banks whose unprecedented policies are crushing interest rates in some the biggest economies, according to the Bank for International Settlements.

As quantitative easing pushes bond investors to look abroad for higher yields and companies flee to foreign markets to borrow more cheaply, they need to hedge their currency exposure. It’s yet another unintended consequence of stimulus that has driven yields below zero on more than $8.3 trillion of sovereign debt, undermined banks’ lending income and raised costs for pension funds that have pledged fixed returns.

“In recent years, the term and credit-spread compression on the back of unconventional monetary policies in major jurisdictions has boosted these cross-currency investment and funding flows,’’ BIS researchers including Claudio Borio, head of the monetary and economic department, said in a quarterly report released Sunday. “In particular, Japanese life insurers’ search for yield overseas has led them to increase FX-hedged investments in U.S. dollar-denominated bonds.’’

Much of the hedging is done using swaps, which allow an investor to borrow one currency from a counterparty while simultaneously lending a second currency to another. A separate BIS triennial survey by the institution showed the daily turnover of swaps climbed 6 percent to $2.4 trillion in April from three years earlier.

Institutional investors use swaps to “strategically hedge foreign-currency investments,” as QE purchases by central banks from Japan to London reduce the availability of securities in their home markets, the BIS said.

“Banks, pension funds and life insurance companies from those economies with low or negative rates have sought to pick up yield by purchasing dollar assets,” said Hyun Song Shin, economic adviser and head of research at the Basel, Switzerland-based institution. “The search for yield has taken on the character of a “flight from zero.”

Negative interest rates outside the U.S. have caused a surge in demand for dollars and dollar assets, pushing up the cost to get into and out of the greenback at the same exchange rate to levels rarely seen in the past. The appetite for dollar assets also presents an opportunity for investors with greenbacks to spare, with Pacific Investment Management Co.’s largest international bond fund and China among the ones tapping into the phenomenon.

Another source of demand for currency hedges is banks, which may fund themselves through swaps in order to hedge their balance-sheet mismatches, the BIS researchers said. Since 2015, Japanese banks have relied more on foreign-exchange swaps for dollar funding due to the lower availability of wholesale funds in the U.S. currency, it added.

Brexit Pressure

Adding to the pressures of sluggish growth in Japan and the euro area, the U.K. vote in June to leave the European Union lent fresh impetus for central banks to adopt easier monetary policy, which further drove down yields. Conservative estimates of the amount of government bonds trading at negative yields surpassed $10 trillion within days after Brexit, according to the BIS.

There are no statistics covering full hedging for all currencies. To quantify the demand, the institution used central bank data for estimates of Australian, euro area and Swedish institutions’ hedged foreign assets, as well as industry sources for Japanese life insurers’ holdings and hedge ratios.

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