U.S dollar cross-currency swaps widen in sign of rising demand as Q4 nears

LONDON/NEW YORK (Reuters) -Demand for U.S. dollars rose in currency derivatives markets on Wednesday, as the last quarter of the year approached and the greenback rose to more than 10-month highs against its peers.

Spreads on three-month euro-dollar, sterling-dollar and dollar-yen swaps were at their widest since December 2020, implying that non-U.S. borrowers are prepared to pay a premium to access dollar funds.

A trader at a bank in London said the moves were due to the fact that "three-month contracts are now capturing the year-end turn, when there is more demand for dollars".

Dollar demand typically rises among corporates and asset management firms as the end of the year approaches, with portfolio rebalancing and fund transfers requiring currencies like the euro and sterling to be converted to the U.S. currency.

The euro-dollar three-month basis swap widened to -22 basis points, from -7.5 on Tuesday, though this is well off levels of around -90 basis points touched in March 2020 when the COVID-19 crisis triggered a scramble for dollars.

The yen three-month cross-currency swap was at -25 basis points, also the widest since December last year.

Traders and analysts said, however, there was no sign of any money market stress, noting that dollar demand tends to rise in the last quarter of each year. This is often because U.S. banks, the main conduit for dollars, cut back lending to meet cash reserve rules.

"In absolute terms, even after this morning's movements we are well above the drains usually observed around year-end," said Daniel Tenengauzer, head of markets strategy at BNY Mellon Markets. He added that the current spread for yen swaps was far narrower compared with the -35 basis points seen near the end of 2020.

The dollar index, though, has surged in recent weeks and is currently at the highest level since last November, boosted by the jump in U.S. Treasury yields amid signs the Federal Reserve could raise interest rates late next year.

Many experts reckon dollar strength will continue.

"The basis swap development reflects the impact of one of the biggest dollar positives that are supporting the currency at the moment – the drain of excess dollar liquidity that should continue to boost the currency's rate and yield advantage," said Valentin Marinov, head of G10 FX at Credit Agricole.

He also linked the moves to expectations the U.S. Congress would approve a debt-ceiling extension, allowing the Treasury to borrow more, just as the Fed prepares to wind down bond-buying.

"The combined impact of the two developments would be to drain the global excess dollar liquidity, in a boost to the currency," Marinov added.

(Reporting by Sujata Rao, Ritvik Carvalho in London, and Paritosh Bansal and Gertrude Chavez-Dreyfuss in New YorkEditing by Pravin Char and Matthew Lewis)