(April 10): By at least one metric in the US$9.5 trillion foreign-exchange markets, demand for the dollar is ebbing amid the tenuous ceasefire between the US and Iran.
Measures of the so-called cross-currency basis — the extra cost investors pay or receive when sourcing dollars overseas instead of the US — show a steady waning in appetite for the greenback in recent days, particularly against the euro and Swiss franc.
“This is a simple reversal of the dollar trade,” said Nathan Thooft, a senior portfolio manager at Manulife Investment Management. “It was one of the few beneficiaries of the crisis as it developed, and now as there are signs of de-escalation that bid is reversing course.”
But while the basis is indicative of the global investor appetite for US cash, it’s not a forward-looking measure of what the dollar will do next. Predicting that is a different task altogether, especially in a market primed to move on the latest war headlines and comments from President Donald Trump.
“It is really difficult to anchor views and portfolio positioning to a single macro narrative right now,” said Thooft, chief investment officer of the firm’s equities and multi-asset solutions teams managing US$309 billion.
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The cross-currency basis market gauges how much it costs to exchange one currency for another beyond what is implied by borrowing costs in the cash markets. It effectively sets the price of foreign-exchange hedging for global investors and is an indication of flows between economies and asset classes.
On Friday the six—month euro basis tightened in favour of the single currency to a level last seen in early March. The Swiss franc’s own gauge, meanwhile, is now at its most favourable in three weeks.
Following the launch of US and Israeli strikes against Iran six weeks ago, these gauges rapidly moved in favour of the greenback — implying a rush for dollar funding as the spiralling Middle East war slammed global risk appetite.
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“The softening of headlines around the conflict have definitely helped risk sentiment and moderated dollar strength,” said Jayati Bharadwaj, head of currency strategy at TD Securities.
If the ceasefire holds, leading to a permanent easing in hostilities, Nomura strategists reckon a long-term trend of de-dollarisation — a broad shift away from dollar-denominated assets due to factors like the US’s unpredictable policymaking and fiscal deterioration — will re-emerge. The bank sees the greenback dropping 4% from current levels by year-end in that scenario.
The cross-currency basis is driven by a wide range of factors, from geopolitical shocks to central bank policies and cross-border bond issuance.
In the mix this week are soft funding conditions as cash continues to flood into short-term US fixed-income markets — a sign that dollar liquidity remains abundant and that investors have ample room to park cash in front-end instruments.
The shift against the dollar in the basis markets signals “a partial return in risk sentiment,” said Jack Boswell, a currency strategist at Wells Fargo in London.
But just as important are tighter funding markets in Europe and the UK as the European Central Bank and Bank of England trim their balance sheets in contrast to the Federal Reserve, he added.
That reflects “a fundamental change in the FX swap market,” Boswell said.
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