But they’re not yet turning to a crisis-era tool to obtain such funding, known as a swap line.
The demand for greenbacks is showing up across the short-term funding markets, particularly where financial institutions and companies go to swap their cash flows into dollars while hedging their currency risk. They often use a tool known as a cross-currency basis swap, which has recently reflected the increasing cost of buying dollars.
A number of factors are running up the price of that instrument. For one, foreign investors want dollars so they can buy fixed-income assets with yields that are higher than in Europe and Japan, where central banks have negative-rate policies. Money market reform, due to be enacted in October, is also making it more difficult for some foreign banks to borrow on a short-term basis. That may lead them to borrow elsewhere and swap into dollars, analysts say.
The rising cost of hedging those swapped cash flows could eventually cause investors to throw in the towel on hedging, and just convert their currencies to dollars on an unhedged basis, a factor that may ultimately push the dollar higher, MoneyBeat reported on Tuesday.
But somewhere along the way, they may consider tapping the Federal Reserve’s foreign exchange swap lines. The swap lines were used during the financial crisis to alleviate the extreme demand for dollar funding. To use it, borrowers must pay 0.50 percentage points more than the short-term lending rate. When it becomes more expensive to use the basis swap market than to use the the swap lines, there’s a possibility borrowers will set their sights on the Fed.
Already, in some locales, the cost of using basis swaps to obtain dollars has exceeded the cost of using the swap line.
But aside from some usage right after the British vote to leave the European union in June, swap line usage hasn’t picked up much. What gives?
One explanation goes back to the swap line as a crisis-era mechanism for times of stress. Citigroup analysts, led by Jabaz Mathai, wrote Friday that using the swap line carries the stigma of being considered a troubled bank. Those that can afford it may be willing to pay more to avoid being seen as at risk. They write:
“The usage of the facility is a function of economic price but more importantly, systemic stress. Systemic stress would first incentivize a few troubled banks to use the facility as survival becomes the first order priority and then other banks would follow as the stigma of being singled out dissipates. On the other hand, during normal times, the stigma costs are likely to be higher as banks would not like to stand out.”
Those foreign institutions may also be getting a nudge from their central banks, according to Credit Suisse Group researchers Zoltan Pozsar and Sarah Smith. The idea is that if foreign institutions need a little help adjusting to the changes happening in the money market, some form of the swap line will be available. But it’s not meant to merely be a cheaper funding tool. They wrote last week:
“As long as markets are continuous and trades get done, the Fed, the [Bank of Japan] and the [European Central Bank] encourage and expect banks to tap private markets, whatever the cost of funds. In other words, the swap lines are not meant to police the euro or yen cross-currency basis – yet. Rather, for now, the purpose of these swap operations appears to be to help banks sail through the storm of money fund reform without a dent in their 30-day liquidity buffers. Dealer of last resort will be another day…”
This article was first published by The Wall Street Journal’s MoneyBeat blog