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Odd Lots

The World Is Awash in Dollar Liquidity That No One Wants

Stacks of one hundred dollar bills pass through a circulator machine at the Bureau of Engraving and Printing in Washington, D.C.
Photographer: Bloomberg/Bloomberg

There's a seismic shift underway in money markets, the equivalent of going from famine to feast.

For years, the premium paid for dollars over the euro, Japanese yen and so on in the cross-currency markets has been negative, indicating rampant demand for greenbacks. Now, these so-called cross-currency basis swaps are on the verge of turning positive in a major shift for money markets.

“Things that haven't happened before are now happening,” says Credit Suisse AG strategist Zoltan Pozsar, in an upcoming episode of Odd Lots. He points out that cross-currency basis swaps are “something that we are used to as being very negative. There's always an excess demand for dollars, and that excess demand for dollars is gone.”

Extraordinary measures from central banks, including the massive provision of liquidity from the Federal Reserve in the form of dollar swap lines and new repo facilities, mean the financial system is essentially swimming in cash. It’s the reversal of an earlier dollar crunch which saw the U.S. central bank withdrawing dollar liquidity from the market in 2015, just as the Bank of Japan and the European Central Bank were ramping up their own quantitative easing programs.

“Some of the most experienced STIR (short-term-interest-rate) traders would tell you that they've never traded as much front-end basis in their career — some of those careers span 30 years — as they did between 2015 and 2019,” says Pozsar of the period. “So then you fast forward to today, we now have so much liquidity, and this is particularly the case for the U.S. dollar that the Fed is doing QE faster than the BOJ or the ECB. So there's just an ample supply of U.S. dollars. Regulations are not getting tighter. If anything, they are getting easier. The Fed has become a dealer of last resort.”

Even cross-currency basis swaps at longer tenors — such as the 10-year swap between the Japanese yen and the U.S. dollar — are on the verge of turning positive. That premium now sits at -34 basis points, the narrowest level in more than a decade.

Such swaps are a way of gauging the difference in the cost of borrowing dollars in Japan versus borrowing dollars in the U.S., with a negative rate indicating that borrowing in yen is more expensive than doing the same in greenbacks. In theory, that difference shouldn’t exist as players arbitrage the differences away, but regulations introduced after the financial crisis may have restricted their ability to do so.