Basis: Crisis pricing melting away; Deutsche eyes USD haven

Fed spring 10 Jun 2020
Panic is melting away like Alpine snow as last night's equinox hints at a new season of hope. Deutsche examines the lack of a USD flight-to-quality.

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  • Crisis pricing melting away

  • Deutsche: Recent turmoil lacking traditional USD funding squeeze

  • Flows


Crisis pricing melting away

The first full day of trading in London after last night’s Spring equinox saw the basis market follow others, such as government bonds and equities. In all of these, crisis pricing melted away like so much Swiss snow in Spring following an afternoon session yesterday that saw an early panic fail to settle.


It is too early to say that the SVB-CS turbulence is over, or that there will not be a burst of contagion to confound and dismay anyone foolish enough to experience feelings of optimism, but basis swappers have at least been kept fairly busy today, if not by new issuance looking for a hedge, but by unwinds of risk-off trades.


This is particularly the case in the biggest market of them all, with the 3m EUR/USD basis currently +8bps at -20.5bps, having travelled from -10bps on Mar 8 to -55bps briefly on Mar 14. Tightening extended as far as the 50y point of the curve which is +1.5bps at -5.75bps (3bps wider than on Mar 8 versus a subsequent low of 8.5bps).


Despite the move in the front end (in cable 3m is also the biggest mover, +2.25bps at -3.25bps), one long-standing basis swapper said that “it’s not particularly active… we’re see unwinds at key curve points all the way along, with flows in 5y and 10y EUR/USD and cable, for example.”


And with EGB yields rising quite a lot there has been the usual flurry of ultralong dated, XVA repricing via trades in 30y (at and around -31.5bps) and 40y cable in particular, and 30y EUR/USD at -15.625bps in particular.


As for new issuance, the trader said he had no specific insight but that “when you look at how USD (domestic) issuance has ramped up today, you’d not be surprised to find a European SSA pencilling in something for tomorrow or Thursday.” US utilities and MetLife were among the domestic names reopening the dollar new issue market on Tuesday. In contrast, non-SSA issuance in has still to get going in euros.


And, he noted, with cable having has the appeal of having been relatively stable versus EUR/USD there is a chance of GBP being the market to re-open significant cross-border issuance, although “demand for bonds, outside of gilts, hasn’t really been tested yet.”


Deutsche: Recent turmoil lacking traditional USD squeeze

Strategists at Deutsche Bank yesterday took a puzzled look at an FX market phenomena of the recent SVB-CS crisis that has also played out in basis. Namely a lack of a significant dash for dollars in the time-honoured fashion of most recent crises.


Deutsche said that the “usage of emergency Fed liquidity by US banks is higher than at the peak of the Lehman crisis. Interest rate volatility last week spiked to the highest on record.

  • Yet one source of market stress has not arrived: a safe-haven demand for the USD. This is highly unusual.”


    It reflected that “previous periods with similar volatility including COVID and the GFC have been associated with at least a 10% rally in the dollar in just a few days. Why is this happening and what does it mean about the future? There is no dollar shortage in offshore markets. While cross-currency basis is widening in short to mid-dated tenors, overnight funding in FX markets remains very well behaved and central bank dollar swap lines remain largely inactive.”


    And even those short-to-mid-tenor cross currency moves, it is far to say, have been of the short and sweet variety. And mild in the extreme compared to past crises, with 7y EUR/USD basis dropping from -20bps on March 8 to a low of -30bps and now quoted at -26.5bps. The first break over the same time has gone from -10 to -42 to -20bps.


    Deutsche continues to say that “there is no immediate dollar cash crunch. While equities and European AT1 instruments have been under pressure, senior credit in banks – arguably a better measure of systemic risk – has not widened that sharply. The market is still not treating developments as a systemic event that challenges day to day bank solvency or funding.”


    Meanwhile, “the Fed is being repriced far more sharply than everywhere else. Over the last two weeks US 1y1y interest rate expectations have fallen by nearly twice as much as everywhere else. Unsurprisingly, the JPY has been the biggest beneficiary. There is more pain in the onshore US banking system than elsewhere. US bank stocks have sold off more than in Europe or Asia over the last two weeks. The emergence or absence of systemic risk outside of the US remains the key variable for the currency market in the short-term. But as soon as this question is resolved, the market will immediately turn to the bigger picture macro question: are developments over the last two weeks more likely to accelerate a dovish Fed pivot versus the ECB and everywhere elsewhere? We continue to believe the answer to this question is yes.”



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