Forex Investment and Currency Trading

Fed goes all out to ease structural demand for USD

As part of the past weekend’s efforts by global policymakers to kick-start interbank lending and get ahead of the financial crisis, the Fed announced that it had lifted the cap on USD swap lines with the ECB, the BoE, the SNB and the BoJ. As a result, counterparties to auctions of USD funds for 7-to 84 days in those four countries would “be able to borrow any amount they wish against appropriate collateral.” Effectively, the Fed is ready to provide unlimited USD funds to deal with the “structural dollar funding shortfall outside of the United States.” On Oct 15, the ECB and the SNB have also announced a swap line to alleviate CHF funding demand in the Eurozone.

One-year cross-currency basis swaps for USD funding reflect strong demand for USD. At the end of Q3, the EUR/USD cross currency basis swap hit -120bp, at the time the highest premium for USD funding. Similarly, GBP/USD, USD/CHF, and USD/JPY cross-currency basis swaps hit record highs. However, the structural demand for USD did not ease at the end of Q3. ECB USD auctions remained well oversubscribed. The coordinated central bank rate cuts on October 8 provided no relief. In fact, with G7 finance ministers to meet on October 10, and uncertainty over the potential response to the global credit crisis, demand for USD funding intensified. The EUR/USD 1-year cross currency swap
averaged -126bp on October 8 to 10.

The ECB has now begun to directly swap USD with counterparties to further enhance USD liquidity.
Demand for USD funding remains extremely high, even though central banks and treasuries are prepared to use “all available tools” and to “take all necessary steps to unfreeze credit and money markets.”