Basis: JPY/USD trumps other movers ahead of ECB

 JPY/USD trumps other movers ahead of ECB

The see-sawing cross-currency basis market continues to rise and fall on the latest sentiment regarding floundering banks, currently Credit Suisse, and today the see-saw was on the rise after the Swiss National Bank vouched for what is half of its big two banking corporations, ahead of a possible takeover by unknown benefactors.

The CS news can be summed up as the central bank promising to keep it liquid, shares bouncing and CS trying to calm the waves with a significant buyback of its own bonds.

And what CS shares do, so do basis swaps. Looking at first breaks, where the big moves have been, one basis swapper in London today said that “EUR/USD is up 10bps today, cable is +5bps, but JPY/USD is up 20bps, although who knows where that market is really trading.”

For more on the JPY/USD basis reaction to the SVB/CS woes, see BNPP below. As for the two basis crosses closer to home, the above trader said that “the curves are bull-flattening as you’d expect in such a risk-on type move. We’ve seen little hedge fund flow though outside of 1y1y flow yesterday where they were receiving but their positions were stopped out…”

The EUR/USD 1y1y traded yesterday from -15bps early on, to -41bps, before bouncing to -35bps late in the day. Currently it is -29.5bps as its opening jump fades slightly going into an ECB meeting where most will be desperately hoping the ECB doesn’t find a way of turning a drama into a crisis.

Aside from the front end, the rest of the curve has been docile, happy to follow a step or two behind where the front end tells it to go. With the slight exception of cable. There, noted the above basis swapper, a roughly 25bps rally in 10y and 30y gilts yesterday was followed by a roughly 10bps rise in yields from yesterday afternoon’s lows in the 30y, versus a 4bps or so rise in the 10y yield.

The basis swapper said that “there is the ongoing cable dynamic whereby 10s30s gilts steepens and 15y plus cable basis is better offered. That’s something we’ve seen today.” As a result, despite a 5.25bps rise in 3m cable, the 30y cable basis is 0.25bps lower at -34.125bps and the 10s30s is 0.5bps flatter at 13bps.

All eyes are now on the ECB where a spicey rates announcement and following narrative from ECB President Lagarde has recently been spiced up by headlines suggesting ECB fears of EU banks being hit with SVB/CS-style problems.

BNPP: 5y JPY/USD widening lagging the front-end move

Strategists at BNPP last night published a note looking at the reaction to the recent bank-led risk-off move by cross-currency basis markets, and specifically the JPY/USD market.

BNPP said that “the most recent widening of xccy basis since 8 March is most likely associated with credit stress with US banks. But the examples of xccy widening driven by credit stress have been relatively rare in the last decade. We think the nearest is March 2020 (first Covid crisis) and November 2011(Euro sovereign crisis).”

“According to our analysis,” BNPP continues, “the 3m xccy basis looks to have widened enough relative to November 2011, but the current widening appears contained relative to March 2020. Current credit stress is probably not as critical as March 2020, based on the different degree of the reaction in risk asset prices. However, we think the 5y widening looks slightly contained relative to both prior periods. The extreme increase of volatility in short-term funding cost (xccy basis) may put further widening pressure on the 5y as borrowers may become more willing to pay cost to secure term funding.”

BNPP contends that the volatility experienced in the short tenor (3m JPY/USD has traded in a -30 to -80bps range over the last week)  may change the behaviour of Japanese banks’ term funding.

It recalls that “in 2011–12, Japanese banks were keen to secure USD term funding to avoid a sharp rise in funding cost if they rolled short-term funding. Until Euro sovereign crisis, European banks tended to fund USD with short term maturity, which turned out to be very painful.”

“Indeed,” BNPP concludes, “it is still cheaper to roll short-term funding, but if the banks take the recent event seriously, there may be some shift to longer-term funding. We could look to establish a flattener, either 1s3s or 1s5s, when the market is more stable. However, we understand that the xccy basis widening may not be over. Therefore, we watch the ongoing developments carefully.”

Flow

Basis trades on the SDR can be seen here: Total Derivatives SDR.