The risk appetite of foreign exchange (FX) derivative users is returning after a long period of anxiety, which stands to benefit Asian currencies while making it cheaper to swap regional currencies into US dollars, believes Frances Cheung, strategist at Crédit Agricole.
At times of high risk aversion, US dollar liquidity usually gets tighter as companies and financial institutions hoard the perceived safe haven currency in order to pay off trade obligations denominated in that currency.
Those without it will go to the cross currency swap, FX swap, and basis swap markets to get US dollar funds, but the rising demand makes such instruments more expensive to trade.
A cross currency swap (CCS) is an over-the-counter instrument between two parties to exchange interest payments and principal on loans denominated in two different currencies. A basis swap is an interest rate swap which involves the exchange of two floating rate financial instruments.
“As today market tension is easing these types of trades will recede, [making the cost to buy US dollars in the] CCS and FX swap market cheaper,” Cheung told Asiamoney PLUS.
One example is the Korean won. In the basis swap market this month the one-year Korean won certificate of deposit rate was offered between -100 basis points [bp] and -215bp over Libor, while on August 30 it was trading at -195bp over Libor.
This broadly indicates that the cost of swapping into US dollars is getting cheaper. This is good news for local importers which are dependent on US dollars in order to settle trade and need to tap the OTC markets. The higher the cost to purchase US dollars, the more expensive it is for their business.