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Fed’s Plan to Ease the Dollar Squeeze Is Working Everywhere Except U.S.

Stephen Spratt and James Hirai
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Fed’s Plan to Ease the Dollar Squeeze Is Working Everywhere Except U.S.

(Bloomberg) -- Signs of strain remain in U.S. funding markets even as the flood of dollars has reduced pressure somewhat in Europe and Asia.

The three-month London interbank offered rate on Thursday notched its largest increase since March 17 as it rose for a 10th straight day.

There is also still unease given the Federal Reserve Bank of New York’s clarification that the Commercial Paper Funding Facility won’t become operational until the first half of April. The Fed is set to buy higher-rated commercial paper at a spread of overnight swaps plus 110 basis points, which is more than 20 basis points below current levels.

Unlike the Money Market Mutual Liquidity Facility, the vehicle created under the CPFF will buy paper directly from issuers, “so we see it as a hard ceiling,” writes Blake Gwinn, head of front-end rates strategy at NatWest Markets.

Meanwhile, yen-dollar three-month cross-currency basis eased, and the euro-dollar equivalent rose to an all-time high.

Here’s a look at how key funding metrics are faring:

Three-Month Libor

Three-month Libor rose 10.763 basis points Thursday to 1.37463%. The jump puts the spread against overnight index swaps, a proxy for the risk free rates, at new post-crisis wides.

Commercial Paper

The spread between where companies borrow these short-term IOUs and overnight index swaps -- the risk-free rate -- has narrowed as participants take advantage of the Fed’s programs, such as the Money Market Mutual Fund Liquidity Facility.

The 90-day AA non-financial commercial paper rate retreated to 1.41% on Tuesday, but the rate on lower-tier non-financial securities rose to 3.51% from 2.71%, according to Federal Reserve data published Wednesday.

See here for a tour guide of the Fed’s famous alphabet soup

Cross-Currency Basis

Euro-dollar three-month cross-currency basis rose to a record, and the equivalent pound-dollar rate touched a two-year high, suggesting that international demand for dollars is abating even as banks continue to seek funds offered by the European Central Bank and Bank of England at daily liquidity operations.

This is being driven by the widening three-month dollar libor spread against overnight index swaps, a component of the basis, as U.S. businesses seek dollars while not all Fed operations are up and running yet.

Yen-dollar three-month cross-currency basis showed a modest easing in the premium for floating rates during the Asia session, as the spread tightened by around 20 basis points.

Part of what pushed up U.S. dollar premiums in FX forward markets last week may have been the unwinding of FX hedge positions in the huge de-leveraging of Japanese government debt held by overseas investors. During the week of March 20, overseas players sold an equivalent of $21.5 billion in Japanese bonds.

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As this flow begins to abate, it may permit some easing in these markets.

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