This is a rather obscure economic update, but I think it is noteworthy.
A shortage of dollar funding suggests that the ability of major institutions to generate profits overseas is becoming difficult.
Briefly, a Cross Currency Swap is a tool that an institution can use to invest in foreign markets, which helps them take advantage of investment opportunities. It is a way to move funds to a nation without having to exchange the money directly, which allows the wealth management sector of the economy, to generate profits for pensions, annuities, and, in general, the diversification portfolios of corporations.
Here’s a brief explanation which I found helpful:
“The reason companies use cross-currency swaps is to take advantage of comparative advantages. For example, if a U.S. company is looking to acquire some yen, and a Japanese company is looking to acquire U.S. dollars, these two companies could perform a swap. The Japanese company likely has better access to Japanese debt markets and could get more favorable terms on a yen loan than if the U.S. company went in directly to the Japanese debt market itself, and vice versa in the U.S. for the Japanese company.” – (emphasis added) Source
For example, if an insurance company’s overseas investment portfolio has a poor yield that quarter (due to poor currency conditions in a foreign market, like Japan) then it will probably charge higher rates to the consumer to compensate for the loss in profits.
Obviously, the worse the cross-currency swap market gets, the more companies will lose profits and the more they will rely on the consumer to stay solvent.
This is something to keep an eye on, I think.
The decline in the cross currency swap basis across most USD pairs in recent months is raising questions regarding a shortage in dollar funding. The fx basis reflects the relative supply and demand for dollar vs. foreign currency funds and a very negative basis currently points to relative shortage of USD funding or relative abundance of funding in other currencies. Such supply and demand imbalances can create big shifts in the fx basis away from its actuarial value of zero. The dollar fx basis weighted across eight DM and EM currencies, declined significantly over the past year to its lowest level since mid 2013, although it remains well above the lows seen during the depths of the Lehman or the Euro debt crisis.
“There are expectations that interest rates might fall further in Europe,” Ohashi said. He said that investors will be interested in bonds of the region’s banks that offer decent extra yields.Japanese life insurers are stopping sales of insurance products that double as savings vehicles because of their falling returns, according to Tatsuo Majima, an analyst at Tokai Tokyo Financial Holdings Inc.“It’s a painful thing for life insurers that their returns on foreign investments are falling,” Majima said.