Dollar swaps blow out as volatile Q3 ignites dash for cash

By Amanda Cooper

LONDON (Reuters) – Demand for U.S. dollars in the currency derivative markets surged on Friday to its highest since the COVID-19 crisis in 2020 as market turmoil sent investors hunting for cash at the end of one of the most volatile quarters in decades.

The three months to September have seen central banks step up their fight against inflation with aggressive interest rate rises, mopping up the cheap cash in the system that built up during the pandemic.

Asset managers hold more cash on their balance sheets than at any time since 2012, according to JPMorgan (NYSE:), while the heads for its third straight quarterly loss – something not witnessed since the financial crisis of 2008.

The dollar has been the main beneficiary, thanks in large part to the Federal Reserve’s pledge to wrestle consumer prices down with as many rate rises as it takes.

Bond yields have responded with a rise so far this year that marks the biggest increase in a nine-month period ever, according to JPMorgan. [LIVE/]

On Friday, three-month euro/dollar cross currency basis swap spreads jumped to -49 basis points, their highest since March 2020, when the pandemic forced the near-complete shutdown of all economic activity.

“This is partly month-end and partly related to other concerns related to liquidity,” Rabobank strategist Jane Foley said.

So far in September, that spread has widened by 46 basis points, the most since September 2008, which marked the explosion of the financial crisis that brought down investment banks like Lehman Brothers and triggered an unprecedented stampede for the safety of the U.S. dollar.

Yen swap spreads grew even more dramatically, reaching -62.75 basis points, the most since March 2020, against a backdrop of historic intervention this month in the currency market by the Bank of Japan, which shored up the yen.

A widening spread indicates that non-U.S. borrowers are prepared to pay a premium to access dollar funds and further such strains on swap markets could eventually force the Fed to run liquidity operations such as repos and swap lines.

The most recent shockwave to hit the financial markets was the Bank of England stepping into the bond market on Wednesday to pin down long-dated yields, after the British government’s most recent fiscal plan sent domestic markets into freefall.

The pound crashed to a record low against the dollar around $1.0327, while British government borrowing costs soared above those for more indebted nations like Italy and Greece.

Sterling cross-currency basis swaps widened more modestly, reaching -28 bps on Friday, their lowest since Russia’s invasion of Ukraine, down from +4 bps on Monday.

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