China's Dollar Swap Addiction
The increased usage of forward swaps is indicative of a lack of market-making ability or ill-liquidity. Delaying the inevitable, i.e. paying later, always comes at a cost. Sooner or later the piper must be paid. And when derivatives are more liquid than cash bonds, what does that tell you about market liquidity or the lack thereof?
Courtesy of The Nattering Naybob at Seeking Alpha
Summary
- Discussion of $1T excess reserve (ER) deposit leveraged by Eurodollar and Euro/USD forward swaps held in NY Foreign Banks.
- Examination of Central Bank Forward FX Swap Usage.
- Analysis of potential forward effects on PBOC and other EM central banks.
- Discussion of effects on the dollar, commodities, global equities and bond markets.
Excerpt:
"If you have a transaction that settles down the road, the actual liquidity impact in the short term may not be as dramatic. Down the road you can't avoid it." ~ Citigroup's Steven Englander
Forward Currency FX Swap
A swap is a financial tool to ease transactions by exchanging certain elements of a loan in one currency, like the principal or interest payments, into an equivalent loan in another currency.
Currency forward is an obligation of two parties to convert an agreed amount of one currency into another by a certain date at an exchange rate specified at the moment of signing the deal.
With forwards, not only are FX reserves conserved for other uses, but buying the local currency in spot markets with UST sale proceeds is not necessary, so the domestic float and liquidity does not suffer. However, future swaps just kick the can forward and can make the settlement of the debt much more costly and difficult.
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USD/CNY Swaps
Below, Bloomberg shows China's increasing use of forward swaps to support the RMB or Yuan.
Due to a global shortage of short term high quality liquid assets (HQLA), China and other EMs are utilizing swaps as a LARGE part of their FX reserves. Making trading days around those settlement or rollover dates potentially more tradable for liquidity volatility and market dislocations.
Euro/USD Swaps
According to Zoltan Pozsar at Credit Suisse…"An uncapped mechanism could cause market dislocations as rapid flows would exacerbate eurodollar and short term UST liquidity issues, in addition to causing another dollar squeeze especially vs Euro."
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