Demand for dollar cash outside the United States surged on Tuesday, with market participants paying sharply higher premiums to get their hands on dollars to tide them over a mid-October deadline to raise the U.S. borrowing limit.
Banks and investors around the world always have a need for dollar liquidity, but do not have direct access to the lending windows run by the Federal Reserve which guarantee U.S. banks easy access to cash.
As a result, they typically pay a premium to raise dollars via the foreign exchange forward markets. As worries over a potential liquidity crunch in the coming weeks have risen, so have those market rates.
The spike in rates came a day before the European Central Bank's weekly dollar auction for euro zone banks.
The benchmark three-month euro/dollar basis swap rate fell to a three-week low on Tuesday, with equivalent dollar/yen rate at its lowest this year.
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That means the premium euro zone banks and investors are paying to access dollars in the foreign exchange forward market was the highest for three weeks, and the equivalent premium for dollars over yen the highest this year.
The premium for two-week dollar funds over euros rose to its highest since March, and the premium over sterling to its highest this year, as market participants looked nervously towards the October 17 deadline.
The rise in these premia doesn't reflect strains in European or Japanese banks themselves as much as a growing need for dollar liquidity over a potential "funding hump'' on the horizon.
"We're seeing a reasonably sharp move this morning - nothing to get too scared about, but we are definitely starting to see some strains now,'' said Chris Clark, rates strategist at broker-dealer ICAP in London.
"This isn't reflecting a change in risk outlook, or a major fundamental risk to the economy or financial system, but a liquidity crunch based around one particular day.''