A scarcity of greenbacks in the swaps market is worsening. This has been a predictor of past trouble, including the 2008 crisis.
King dollar is rising. Other currencies are falling like ninepins. But to gauge the impact of this surge on Asia, you have to move beyond spot exchange rates and into an esoteric corner where tens of trillions of dollars of off-balance-sheet debt lives in the accounting footnotes of banks, investors and even central banks.
That corner is currency swaps.
These are deals in which parties exchange funds from one currency into another and reverse the trade, say, five years later. Every three or six months, each earns a benchmark money-market interest rate in the currency it bought and pays interest in the currency it sold. The greenback is usually involved, and a basis swap spread is a measure of how much more a bank has to pay to borrow dollars by this circuitous route rather than taking an outright Libor loan. An average of the spread on G-10 currencies is an indicator of the punishment for wanting and not having the U.S. currency.
Theory says there should be no such dearth of dollar funding obtained synthetically, but since the 2008 crisis there’s a scarcity that comes and goes, signalling fear ahead of rockiness in the global economy. Right now, the dollar squeeze isn’t awful, but its worsening, with implications for everyone from Japanese banks and South Korean insurers to the Indian government.
Start with the poor, rich Japanese banks. If staying home is no fun for them, going out is worse right now. Money is so cheap in Japan that banks are paid to borrow in yen. That crimps the profitability of their domestic lending business. But what happens when they try to make a little bit of assured profit on those borrowed funds by buying, say, U.S. bonds? On a 10-year Treasury note, they lose an extra 40 basis points over and above the negative 20-basis-point yield on a Japanese security of similar maturity.
A Tokyo mega bank that wants to raise financing against safe U.S. bonds to make a dollar loan to, say, Masayoshi Son, is caught on the wrong foot as hedging costs make Treasuries costly to own for Japanese buyers. Banks whose home currency is dollars will be able to offer cheaper loans.
Korean insurers are in a similar boat. Unable to earn what they’re crediting to their policyholders, they’re also desperate for higher-yielding foreign securities. But if they buy 10-year U.S. Treasuries, they effectively surrender nearly 80 basis points of the 1.2 per cent yield on the sovereign Korean bond. As the Korean central bank cuts rates further, meeting policyholders expectations will become onerous....MUCH MOREProbably related
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