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Expensive Dollars And The Return Of Negative Hedged Yields

"This might be telling us that there is a growing USD shortage developing."

Late last week, hedged Treasury yields turned negative for European and Japanese investors, a state of affairs that garnered quite a bit of attention as these things go, despite being the clear result of quarter-end effects.

The 3-month EURUSD X-Ccy basis fell 25bps on Thursday, the largest one-day move since 2009 (see below) and similar action unfolded in the 3-month USDJPY basis.



Here’s the hedged yield for European and Japanese investors:



This is obviously down to 3-month tenors capturing year-end. Here’s BofAML documenting the same dynamic for foreign investors in USD corporate bonds:

Thursday, the cost to hedge FX risk moved sharply higher for foreign investors that hedge USD corporate bond holdings by rolling 3-month FX forwards. On an annualized basis the 3-month hedging cost jumped 47bps to 318bps for JPY/USD and 23bps to 323bps for EUR/USD. The reason for these sudden increases is the fact that the three-month FX forward contract extends over the year-end today for the first time this year. It is more expensive because banks, and in particular foreign banks, make an effort to minimize their balance sheets on December 31st for regulatory reporting purposes. As a result these FX hedging costs will likely remain elevated for the remainder of 2018 and normalize on the first day of the new year – a pattern that repeats every year.


Calendar effects aside, this is obviously something that’s worth monitoring in the context of the USD shortage narrative and amid Fed tightening and balance sheet rundown.

On those points, Nedbank is out with something new on Tuesday that’s worth a mention.

“Since the Fed stopped growing its balance sheet and with the introduction of Basel, the costs of USD funding has also remained relatively expensive”, the bank writes, adding that they believe this “will persist as we operate in a structural environment where $’s are scarce (global trade, Fed QT, lower commodity prices)”.



The bank’s Mehul Daya goes on to note that while quarter-end window dressing usually drives up the cost of raising dollars, “in recent days USD basis has failed to reverse and is accelerating which might be telling us that there is a growing USD shortage developing.”

What’s that down to? Well, for Daya, it could be attributable to the Italy turmoil, but he notes that “the cost of raising USD across a number of G10 FX is rising” which leads him to postulate that “this could be more serious.”


Other factors at play could include “Fed QT or replenishment of US treasury call account or just general risk aversion (IL&FS, Turkey etc.)”, Daya continues, before noting that the implications are a stronger dollar and higher yields “amid a lack of foreign buyers given eroding returns” which is “especially relevant for Japanese investors.”

Make of all that what you will.



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