Dollar borrowing costs hit three-year high as Fed/ECB policies diverge

[November 11, 2015]  —  By Anirban Nag

LONDON (Reuters) - The cost of borrowing U.S. dollars hit its highest in over three years on Wednesday, a factor that some traders and analysts say will boost demand for the greenback in the currency market into the year end.

The three month euro/dollar cross currency basis swap <EURCBS3M=ICAP>, the premium an investor demands to swap euro-interest rate exposure into dollar-denominated rate exposure, hit minus 46 basis points, the widest since July 2012.

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"A new dollar-supportive driver is emerging beyond the widely understood central bank divergence story: the rising cost of dollar funding," said George Saravelos, currency strategist at Deutsche Bank.

Effectively, the cross-currency basis swap is a measure of demand for dollars or of the surfeit of euros in the system.

The basis swap hit minus 305 in the wake of the 2008 Lehman Brothers collapse when money markets had frozen and there was a rush to hold dollars. At the height of the euro zone crisis in 2011, the gauge was at minus 160 points.

The measure has widened sharply in recent days since U.S. Federal Reserve Chair Janet Yellen flagged a possible December rise in interest rates and a blockbuster U.S. jobs report cemented expectations of a hike next month.

In contrast, the ECB is considering additional monetary stimulus to boost inflation and growth and markets expect it to lower its deposit rates further into negative territory.

With the policy divergence between the two central banks seen as a major driver in currency markets, analysts said the move in the cross-currency basis swap was likely to support the dollar, especially against the euro. <EUR=>

Analysts said a combination of factors including funding constraints, a lack of liquidity before year end, regulatory changes for banks and demand for dollars ahead of Fed lift-off were also pushing up the borrowing costs for dollars.

Alexander Wojt, an interest rate strategist at Morgan Stanley said the recent move could continue into the first quarter of 2016.

He added trans-Atlantic credit issuances were likely to pick up and could see the gauge widen. Bonds issued by U.S. companies in euros have picked up in recent years amid falling interest rates in the euro zone. Dubbed as "Reverse Yankee" bonds, borrowing in euros lowers interest expenses and debt levels for U.S. companies, if these bonds are fully hedged.

"The risk, looking into the last month of issuance of this year and in particular into first quarter 2016, is that the ECB easing and the Fed tightening could result in continued significant cross-market issuance trends," Wojt said.

"In February and March this year we saw how these flows pushed EURUSD wider and we think the risks are skewed in that direction over the coming months."

(Additional reporting and graphic by Jamie McGeever)

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