In the exchanges we trust? The disappearance of dollars leads to dependence on currency trading


LONDON (Reuters) – As dollars dry up, global finance increasingly depends on opaque currency trading to maintain cash flow.

FILE PHOTO: The euro and US dollar exchange rates are seen on an electronic board as a man points to it on the floor of the Brazilian B3 stock exchange in Sao Paulo, Brazil, July 25, 2019. REUTERS / Amanda Perobelli / File Photo

Banks and other short-term dollar borrowers are increasingly dependent on the $ 3.2 trillion-a-day currency swap market, the data shows, putting them dangerously at risk if U.S. lenders stop funding the system. if only temporarily.

Swap users were scared in September, when the US Federal Reserve had to pump money into the markets as US market rates “repo” $ 2.2 trillion (£ 1.7 trillion). sterling) skyrocketed and spread across the currency swap markets, sending the bounty for borrowing dollars. upper.

“It has affected us a lot in the currency swap market. There was a lot of panic around, widening spreads, increased volatility, ”said James Topham, a currency futures trader at Canadian bank BMO, adding that on September 16,“ unusually large and persistent ”were evident from customers.

Such reminders of potential disruption to the “plumbing” of money markets, best exemplified during the 2008 financial crisis, put regulators on their guard for anything that could trigger a repeat.

Some now fear that swaps could be that catalyst, perhaps as early as late 2019, if U.S. banks, the dollar’s main conduit, cut lending to meet cash reserve rules.

“Towards the end of the year… the normal supply dynamics will be rejected,” Topham said.

Stricter regulations requiring lenders to hold at least 8% of equity in reserves, rising U.S. protectionism and repatriation of corporate cash are all reducing the supply of dollars.

Reflecting the increased reliance on foreign exchange markets to borrow dollars, foreign exchange swap volumes increased to represent 49% of total currency exchanges, from 42% in 2013, figures from the Bank for International Settlements (BIS) d ‘August show.

Chart: Turnover in OTC currencies –

This has led the International Monetary Fund (IMF) and the BIS, as well as monetary policymakers such as the European Central Bank, to remain vigilant as the dollar’s cost of borrowing has increased slightly over the past decade, causing it to remain vigilant. makes it more costly for the banks and global companies to finance investments.


Unlike traditional “spot” currency transactions, swaps involve two parties exchanging one currency for another. The repayment is made after a determined period and fixed at a forward exchange rate determined by the difference in interest rates on the two currencies.

Many central bankers claim that bank borrowing and financing through swaps, which are typically used for hedging, overnight liquidity management, or even speculation, causes currency swaps to increase because they are “out of the box”. balance sheet”.

This is good for banks and businesses because the lower their debt, the higher their credit rating. It is also cheaper to hold less debt on the balance sheet.

A central bank official said authorities were monitoring the end of 2019 period, but also worried about the ability of borrowers to refinance.

“Much of the FX trading activity is very short term. This could expose banks to significant refinancing risks, ”the official added.

Borrowing through swaps could amount to $ 14 trillion or more, estimated Claudio Borio, head of the BIS ‘monetary and economic department.

And the dollar funding gap, the difference between the dollar assets and liabilities of non-US banks, could reach $ 1.5 trillion, said Tobias Adrian, director of the IMF’s monetary and capital markets department.

“A lot of this has to be funded in the currency swap markets, and those markets can be fragile,” Adrian told Reuters.

While the IMF has a “very granular breakdown” of FX swap borrowing and risk managers typically stress tests on banks, Adrian said this remained a “concern”.

The central bank official said stress tests implied that some banks use swaps for more than 10% of their funding, while the BIS says dollars make up 90% of all currency transactions.

Because the demand for dollars is so high, lenders ask for a price premium known as cross currency basis, which tends to become more negative as dollar shortages worsen.

This is increasingly costly for non-US banks without dollar deposits and dollar denominated collateral, and these have to turn to swaps to finance trade and hedge investments.

Other dollar-dependent borrowers, particularly in emerging markets, are also suffering.

In addition to US banks, potential winners could include petrodollar liquidity providers such as the big oil companies.


Money market traders and regulators don’t expect a repeat of the crises of 2008 and 2011, when dollar borrowing dried up outside the United States as U.S. banks piled it up at home.

September’s spike in reverse repo rates eased as the Fed injected liquidity into money markets and swap rates also fell.

While the global dollar swap market lacks such a safety net, central banks outside the United States can provide dollars through “emergency liquidity assistance”, aimed at financial institutions facing financial crisis. temporary liquidity problems.

“We have dollar liquidity that depends in part (on) the currency swap market because we don’t have dollar deposits. But we regularly test the ECB’s ability to provide us with dollar liquidity through currency swaps. We have no problem with that, it’s not a problem, ”said a French banking executive.

Nonetheless, as the end of the year approaches, traders are on the alert as large U.S. banks often reduce cash on deposit with the Fed to comply with rules requiring them to display sufficient cash reserves. , which means they lend less dollars.

This causes periodic spikes in dollar funding premiums “in currency swaps and repo,” said Olek Gajowniczek, a trader at Japanese bank Nomura, adding that regulations have made it more difficult for the market “to absorb. unlimited amounts of currency swaps ”.

Before the 2008 financial crisis, the basis swap between the dollar and major currencies was negligible but has since fluctuated between minus 20 and 50 basis points, while in some countries it has gone beyond minus 100 basis points. base, Adrian said.

The three-month euro-dollar basis swap, for example, is around minus 22 basis points, but peaked beyond minus 300 basis points in October 2008. It hit minus 42 basis points. a month ago when a money market squeeze pushed overnight repo rates to 10% in New York City. .

“We estimate that when the base widens by 50 basis points, the financial stability risks in the home country of institutions increase and they reduce lending,” Adrian added.

Chart: Funding markets in dollars –

Traders such as BMO’s Topham have become accustomed to trading market volatility in December – since 2008, it is common for the base swap premium to rise towards the end of the year only to readjust soon after, a he declared.

However, he remains vigilant.

“It looks like the dollar’s liquidity is still there, but is obviously close to a level where little things can cause big price changes,” he said. “We learned that a bit in September.

Report by Olga Cotaga; Additional reporting by Megan Davies, Maya Nikolaeva and Tommy Wilkes; Graphics by Saikat Chatterjee; Editing by Alexander Smith


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