As dollar funding improves, basis swaps tighten

Dollar funding costs inched down on Wednesday and tighter cross currency swap differentials revealed further improvement in dollar liquidity across markets from Europe to Asia.

While the improvement in spreads has been modest but steady, it appeared to be linked to the pick up in risk appetite across stocks and asset markets as signs of a bottoming in the global economy enticed more lenders into the cash markets.

3-month dollars are quoted at 1.14706 percent, down from 1.15741 on Tuesday and closer to this year's trough at 1.09 percent in mid-January.

"The daily Fed effective trading sub 0.20 percent consistently is helping at the margin and equity market strength has certainly been encouraging 3-month LIBOR rates lower," said Sean Keane, managing director of Triple T Consulting and a former strategist at Credit Suisse.

The effective rate of borrowing between banks in the United States has drifted down gradually and now rests in the middle of the Federal Reserve's policy range of 0 to 0.25 percent.

More importantly, dollar lending strains in markets outside the United States has improved, evidenced by the tightening in cross-currency basis swaps — a measure of the cost of swapping other currencies into dollars.

Euro-dollar one-year basis swaps were quoted at minus 40 basis points (bps), far tighter than levels of minus 100 in November and minus 57 a month earlier.

Basis swaps are quoted as a spread over dollar LIBOR to obtain funding in another currency, and so a deeply negative basis indicates market players are willing to pay a steep premium for dollar funding.

Yen-dollar two-year basis swaps have tightened from minus 59 in February to minus 40.

Standard Chartered Bank analyst Christophe Duval-Kieffer said in a note the evidence from the basis swaps pointed to dollar funding markets having reached a turning point.

"Actions by central banks have eventually reached a critical mass sufficient to counterbalance the impact of strong demand for cross-currency funding," Duval-Kieffer wrote.