Dollar Funding Is Freezing Up, and the Fed Knows It

(Bloomberg Opinion) -- Demand for U.S. dollars is so high that now there’s a squeeze in credit markets. And the Federal Reserve knows it.

Big corporations from beer brewer Anheuser-Busch InBev SA to Boeing Co. are drawing down billions from their credit lines. Fearful of margin calls and flash crashes, lenders are piling on reserves. Adding to the hair-raising market volatility, banks that typically provide short-term dollar loans are stepping back.

To ease the strain in dollar borrowing, the Fed took action Tuesday, restarting a commercial paper funding facility for U.S. corporates. It also allowed banks and broker-dealers that trade directly with the Fed to borrow cash secured against some stocks and higher-rated bonds.

But that doesn’t do much to ease funding tightness overseas. For evidence, look no further than currency swaps, which measure how expensive it is to borrow in dollars. If a Japanese bank wants to offer a dollar loan to a client, the bank, pocketful of yen deposits, would typically lend its yen in exchange for an American bank’s dollars using currency swaps. This practice is common across Asian markets — and the costs are soaring.

Since the global financial crisis, foreign banks’ dollar lending has ballooned to $12 trillion from $10 trillion, the International Monetary Fund estimates. Lenders abroad like this business because dollar assets tend to offer higher returns and companies prefer to borrow in the currency.

Now, this key corner of the funding market is in trouble. The three-month euro-dollar basis swap slumped to as much as negative 122 basis points Tuesday, the widest since December 2011. That’s despite the Fed promising to boost liquidity via its swap line with the European Central Bank just two days earlier. Stocks fell during European trading hours as investors feared a squeeze.

If the euro swap’s explosion was just a blip, how about markets without a direct line to the Fed? Dollar liquidity conditions in Asia have been tightening recently, too. In South Korea, the one-year won basis swap widened to about negative 90 basis points, from negative 55 basis points only two weeks earlier. Meanwhile, in Hong Kong, dollar funding is as tight as the 2011 European financial crisis, going by data from cross-currency swaps.

In the asset management world, the dollar is still the king. If it’s hard to get a hold of them, that doesn’t bode well for risk assets.

Just look at the Korean won, which sank to a 10-year low Tuesday, even though Seoul has been doing a lot of the right things, accumulating its foreign currency reserves and reducing its reliance on short-term external debt. Meanwhile, some Korean stocks have become dirt cheap. The country’s banks, for instance, are trading at only 0.2 times book, data compiled by Bloomberg Intelligence show, making them almost as unloved as the industry’s basket case, Deutsche Bank AG.

Then consider Hong Kong. In February, even with China in the throes of the virus outbreak, the dollar bond market stayed afloat, with mainland developers raising a whopping $6.4 billion. But the funding squeeze has changed the calculation entirely: The total value of Chinese dollar bonds yielding above 15% more than doubled from a week ago. That means China Inc.’s borrowers will have to pay a lot more — and, unfortunately, the offshore market is about the only place big enough to place the half-a-billion-dollar issues they rely on.

While the Fed has taken action on American soil, it could expand its swap lines with more central banks. It’s understandable that the Fed doesn’t want to be the world’s lender of last resort, but it’s a little too late for that: The dollar greases the pipes of global finance. Funds can’t flow freely if things are clogged on the other side of the Pacific.

In its latest financial stability report from October, the IMF worried about the role foreign banks serve in dollar funding. Currency swaps tend to be short-term, volatile and costly, it warned. The coronavirus is only drawing out that instability.

This column does not necessarily reflect the opinion of Bloomberg LP and its owners.

Shuli Ren is a Bloomberg Opinion columnist covering Asian markets. She previously wrote on markets for Barron's, following a career as an investment banker, and is a CFA charterholder.

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