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US Dollar Surges on Funding Market Distress Signal: Risk of Explosive Breakout

US Dollar Surges on Funding Market Distress Signal: Risk of Explosive Breakout

Justin McQueen, Strategist

US Dollar Analysis & News

  • US Dollar Surge Amid Distressed Funding Market
  • US Dollar to Break 100?
  • 2008 Recession Saw Greenback Surge 15%

US Dollar Surge Amid Distressed Funding Market

Last week we highlighted that distress signals were beginning to grow louder as cross currency basis swaps were beginning to widen (Xccy Basis Swap), which in turn emphasises concerns over a dollar shortage. Consequently, this had prompted the Federal Reserve to announce a $1.5tln liquidity boost via repo operations before announcing another rate cut in the target range to 0-0.25%, alongside a restart in the QE program and USD swap lines. However, despite this, the US Dollar has taken the aggressive easing package within its stride and continued to strengthen as Xccy basis swaps have widened further, raising the cost of dollar shorts as supply dries up (Figure 1).

Figure 1: US Dollar Shortage to Boost the Greenback

US Dollar Surges on Funding Market Distress Signal: Risk of Explosive Breakout

Source: Refinitiv.

Example: If a European company takes out a 3-month loan from its local bank to pay for its US business overseas. In order for the company to hedge the currency risk, the company would enter into a 3-month EUR/USD currency swap with a counterparty. A certain number of Euros to US Dollars would be swapped at the current rate while also agreeing to swap the funds back in 3-months’ time. Given that the European company is borrowing dollars they would have to pay out US libor interest and receive Euribor interest (reminder Euribor is negative and therefore would have to pay out Euribor).

If 3-month US libor was 0.85% and Euribor is -0.45%, the cost of the swap to the European company is 1.3%. With concerns of a dollar shortage, the counterparty quotes a basis of -110bps, meaning that the cost of the swap to the European company would increase to 2.4%.

US Dollar to Break 100?

A continued widening in basis swaps would likely lead the US Dollar to extend on its recent gains. Of note, according to BIS data, total bank loans and debt securities issues, by residence of non-bank borrower highlights that US Dollars funding is at over $12tln, with Euro and Japanese Yen funding at $3.5tln and $440bln respectively. As a reminder, the US Dollar soared over 15% as cross currency basis swaps saw explosive widening.

US Dollar Price Chart: Weekly Time Frame

US Dollar Surges on Funding Market Distress Signal: Risk of Explosive Breakout

--- Written by Justin McQueen, Market Analyst

Follow Justin on Twitter @JMcQueenFX

DailyFX provides forex news and technical analysis on the trends that influence the global currency markets.