It was just over a year ago when we first observed a troubling development in the global currency funding arena: the global dollar funding shortage had come back after a 7 year hiatus, and "this time it was different."
The reason for this observations was predicated in the collapse of USD basis swaps. This is what HPM said at the time:
The decline in the cross currency swap basis across most USD pairs in recent months is raising questions regarding a shortage in dollar funding. The fx basis reflects the relative supply and demand for dollar vs. foreign currency funds and a very negative basis currently points to relative shortage of USD funding or relative abundance of funding in other currencies. Such supply and demand imbalances can create big shifts in the fx basis away from its actuarial value of zero. The dollar fx basis weighted across eight DM and EM currencies, declined significantly over the past year to its lowest level since mid 2013, although it remains well above the lows seen during the depths of the Lehman or the Euro debt crisis.
JPM's then-conclusion was that "different to previous episodes of dollar funding shortage such as the ones experienced during the Lehman crisis or during the euro debt crisis, the current one is not driven by banks. It is rather driven by the monetary policy divergence between the US and the rest of the world. This divergence appears to have created an imbalance in funding markets and a shortage in dollar funding. It is important to monitor how this dollar funding shortage and issuance patterns evolve over time even if the currency implications are uncertain."
Fast forward one year when overnight Bloomberg followed up on the topic of the global dollar funding shortage, by looking at FX basis swaps in Japan and concluding that "the Bank of Japan’s negative interest rate policy is making it more expensive for domestic banks to hedge dollar investments, threatening to slow their escape from negative rates into U.S. currency debt."
As we explained in extensive detail last March (here), when Japanese financial institutions want to secure dollar funds for overseas investments, they often chose trades that involve swapping greenback and yen interest rates, instead of taking on exchange rate risk by trading currencies. That premium for Yen holders has continued to soar since last March when we first profiled it, and reached a record 102.5 basis points last week, dropping modestly to 98 on Wednesday.
While Kuroda may ignore the precarious dollar funding shortage, others are far less sanguine: "The jump in basis swaps is an extremely serious problem,” said Hidetoshi Ohashi, the chief credit strategist in Tokyo at Mizuho. "If it continues widening, financial firms will need to reduce their overseas holdings or diversify their investments into other regions."
Not everyone will be impacted equally, with Japan's largest banks - Mitsubishi UFJ, Sumitomo Mitsui and Mizuho - likely exempt from rising basis swaps and USD funding shortfalls because they can raise dollar funds by selling bonds overseas, according to Yoshinobu Yamada, a senior analyst at Deutsche Bank AG in Tokyo. However "investors such as life insurers will have problems when they want to put their money in foreign bonds if costs are rising,” Yamada said. Mizuho’s Ohashi said Japan’s regional banks will also be affected.
If not the US, Japanese hot money has another option: Europe, where the ECB lowered negative rates further last week, according to Mizuho’s Ohashi. The premium for yen holders to borrow the single currency until 2021 was 44.8 basis points on Wednesday, less than half the cost to secure dollars. However, yields in Europe are likewise far lower, than in the U.S., which means that when netting out the swap premium the net benefit to investors will likely even out.
Which leaves companies like insurers who have to find way of boosting the yields on their investments in a pickle:
“There are expectations that interest rates might fall further in Europe,” Ohashi said. He said that investors will be interested in bonds of the region’s banks that offer decent extra yields.
Japanese life insurers are stopping sales of insurance products that double as savings vehicles because of their falling returns, according to Tatsuo Majima, an analyst at Tokai Tokyo Financial Holdings Inc.
“It’s a painful thing for life insurers that their returns on foreign investments are falling,” Majima said.
Majima should just complain to the BIS: after all it is this most hypocritical of organizations, whose members are the central banks themselves, that keeps warning about the risks of ongoing easing and central bank intervention, at a time when all four major central banks have just proceeded to engage in major easing, and moments ago the BOJ directly sold Yen in the open market. Surely all that merits at least one more angry letter by the BIS Jaime Caruana?