The cost of raising US dollar funds in the European currency swap market surged on Friday, suggesting increased demand for the greenback and heightened funding stress related to debt concerns in both the United States and euro zone.
The cross-currency basis swap, or the relative premium for swapping euro LIBOR for dollar LIBOR, traded at -36.75 basis points on one-year contracts on Friday, its highest since February. On Thursday, one-year swaps closed at -36.50 basis points
Three-month cross-currency swaps were at -50.75 basis points on Friday, its highest since January from -45.50 basis points on Thursday Wider spreads reflect elevated demand to borrow US dollars in the currency forward market and often supports the greenback's spot value against the euro.
"While part of this may stem from renewed stresses in some of the European sovereign debt markets, the US debt ceiling impasse may also be contributing to it as well," said Bob Lynch, chief currency strategist, at HSBC in New York. "Despite the fact that the dollar is seemingly at risk from the debt impasse, the stress and uncertainty associated with the process seems to have increased demand for dollar funding among non-US banks."
Analysts said swap spreads between 30-40 basis points are a warning signal and would be problematic if they get into the 50s area. One-year swaps had widened to record levels during the post-Lehman bankruptcy period in November 2008 when spreads surged to -102 basis points. That led to the introduction of currency swap lines between central banks, partly dampening the pressure on short-term dollar financing. Traders said price action in the FX swaps market goes in hand in hand with movements in the euro/dollar exchange rate, with a robust correlation rate of almost 60 percent on a 25-day rolling basis.
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