March 17, 2020 / 3:33 PM / 11 days ago

Show me the money: Dollar funding squeeze eases after Fed facility report

LONDON (Reuters) - Demand for dollars in the currency derivative markets spiralled to multi-year highs on Tuesday before slipping back after Reuters reported that the Federal Reserve was preparing to take more steps to ease the logjam in a key shorter-term cash market.

It remains to be seen if the resumption of a facility called Commercial Paper Funding Facility (CPFF) in the United States will prove more effective than the interest rate cuts and cash injections central banks have deployed.

But swap moves abated from the extremes seen earlier in the day.

FX implied dollar borrowing costs had been blowing out as banks held on to their dollars and braced for a wave of corporate demand for shorter-dated cash and a possible spike in loan defaults.

“We are looking at funding stresses in the corporate sector as the real economy stands completely disrupted, and aggressive monetary policy actions alone will not help,” said Alberto Gallo, head of macro strategies at Algebris Investments, a London-based hedge fund.

Three-month euro/dollar three-month FX swap spreads reached their widest since the 2011 euro zone debt crisis at 124 basis points, then narrowed to around 59 bps after the Reuters report. The rate had been around 20 bps in early March.

A wider spread indicates market participants are willing to pay a higher premium for dollars.

Similarly, the pound/dollar swap spread narrowed to 53 bps after ballooning to 90 bps earlier, the widest since December 2008.

However, the dollar/yen basis swap - the premium investors pay over interbank rates to swap yen into three-month dollars - tightened to 95 bps from 140 bps earlier.

That swap spreads have widened so much despite central bank efforts to keep cash flowing shows the pain that companies face as much of the global economy shuts down.

For an explainer on money markets and FX swaps:

“What it tells you is that somebody is deeply deleveraging and is in real need of dollars,” said Sebastian Galy, a senior macro strategist at Nordea Asset Management.

“There is blood on the street — we just don’t know where it is.”

Now, investors will keep a close eye on the U.S. commercial paper market, where companies tap funds for shorter-dated loans and which has been more or less frozen.

REACHING LIMITS

Following the coordinated round of interest rate cuts led by the Fed’s 100-basis-point cut on Sunday, some of the biggest banks in the United States said they would access the Fed’s discount window, a facility aimed at providing emergency liquidity to banks.

Earlier on Tuesday, the Japanese central bank pumped $30 billion into markets with an 84-day dollar funding operation, its biggest since late 2008.

In a sign liquidity issues are not much affecting the interbank market, so called FRA-OIS spreads — essentially a gauge of the risk banks attach to lending to one another — had come off highs.

But after the Reuters report on the possible Fed measure, the three-month FRA-OIS eased further to 58 bps, well off multi-year highs of 75 bps hit in the previous session.

Algebris’s Gallo said, however, that monetary policy had reached its limits and the “game changer” was fiscal stimulus. That seems to be underway — the U.S. government will seek about $850 billion in funding to boost its economy and Britain plans a rescue package for businesses threatened with collapse.

Reporting by Saikat Chatterjee and Tommy Reggiori Wilkes; graphic by Ritvik Carvalho; editing by Kirsten Donovan, Sujata Rao and Larry King

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