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Signs of strain are emerging in currency markets as traders struggle to gauge the impact of tougher Western sanctions on Russia on liquidity.
The spread between future Libor and Fed rates – the FRA/OIS spread – widened 10 basis points for one-month contracts, the most since March 2020. Other key market indicators markets fluctuated, notably three-month dollar-yen basis swaps, while March eurodollar contracts underperformed their June peers.
The moves may reflect traders’ fears that dollar funding costs could rise as tensions in Ukraine escalate. The decision to exclude various Russian lenders from the SWIFT messaging system could lead to missed payments and prompt monetary authorities to supply the market with dollars, according to Credit Suisse Group AG strategist Zoltan Pozsar.
“The details on the sanctions were quite vague, so the market will look for more clarity, but there is no doubt that the purpose of the sanctions is to cause a liquidity crisis within the Russian economy,” said Prashant Newnaha. , Asia Pacific Rates Strategist at TD Securities. “Initial basis moves are not too surprising, a classic risk move, as spreads are wide and liquidity thin.”
The disruption added to fears that the impact of the Ukraine crisis could strain fixed-income markets that were already showing signs of dysfunction as the Federal Reserve and its peers accelerated policy tightening plans.
The three-month dollar-yen basis swap – which helps manage the costs for traders to swap interest rates between currencies – fell 29 basis points to minus 64 basis points as demand for dollars was increasing. This indicates that dollar funding costs have jumped for yen-based investors to levels last seen in March 2020.
Russia’s SWIFT ban means the Fed may have to prepare dollars (1)
Russia had around $300 billion in foreign currency held abroad – enough to disrupt money markets if it were frozen by sanctions or suddenly decided to avoid them – Credit Suisse Group estimated last week .
Newnaha said a key question is whether funding strains carry over into the European day, when there is generally more liquidity.
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