Hedging Currency Risk Gets More Expensive As Year-End Approaches

It’s getting pricey for foreigners to snap up U.S. bonds without the currency risk. A type of derivative used to buy dollar funding using other currencies is once again getting more expensive. So-called cross-currency basis swaps show that using Japanese yen funding to buy dollars for a period of three months now costs 0.48 percentage point above going rates, up from 0.28 percentage point on Sept. 15, according to Thomson Reuters data. A similar phenomenon is playing out in Europe, with the comparable three-month euro-dollar basis swap cost climbing to 0.44 percentage point above going rates from 0.27 percentage point at mid-month. On an annualized basis, those costs add up for the investors and financial institutions looking to hedging their currency risk…The explanation for what’s happened in recent days is fairly straightforward, according to Bank of America Merrill Lynch. The banks that trade these contracts tend to shrink their balance sheets at year-end when regulators do a read on capital levels. As we get further into the fall season, the widely-used three-month contracts now span across that year-end period. Banks are becoming more conservative about providing that funding because they’re more mindful of keeping it on their balance sheets. Less available funding means higher costs.