A measure of demand in the $7.5-trillion-a-day foreign-exchange market is catching the attention of Wall Street, pointing to diminished appetite for the US dollar even during market turbulence that would otherwise send investors flocking to the greenback.
Analysts at a handful of banks including Morgan Stanley and Goldman Sachs Group Inc. all point to recent shifts in so-called cross-currency basis swaps — a gauge of how much it costs to exchange one currency for another beyond what would normally be implied by borrowing costs in the cash markets. As demand for a particular currency increases, that extra cost or premium rises, and likewise declines or even can go negative when appetite isn’t as strong.
These analysts note that when markets melted down in April following US President Donald Trump’s “Liberation Day” tariff announcement, the preference for dollars as measured by basis swaps was relatively minor and short-lived. Meanwhile, demand for other currencies such as the euro and yen has grown. That stands in sharp contrast to previous scrambles for safety over the last two decades, such as the onset of the pandemic, which saw the dollar command a premium in global funding markets for a sustained period.
Over time, this waning preference for dollar liquidity, particularly relative to the euro, could ultimately make it more expensive to borrow Europe’s common currency relative to the greenback — presenting a challenge for the US currency at a time when its preeminent position in world finance is facing growing doubts.
“Recent cross-currency basis movements suggest investors have less appetite to buy dollar-denominated assets and more appetite to buy those denominated in euro and yen,” the Morgan Stanley team including Koichi Sugisak and Francesco Grechi wrote in a June report. In fact, the US tariff impact appeared to be “triggering a temporary withdrawal from dollar assets,” the Morgan Stanley analysts wrote.
The cross-currency basis matters because it effectively sets the price of long-term, foreign-exchange hedging for companies and investors the world over. It’s also an indication of the shifting trends in vast flows of assets between economies and asset classes.
Already, the Bloomberg Dollar Spot Index is down more than 8% this year — the measure’s worst start to a year since the gauge launched two decades ago. The focus on basis swaps comes at a time of a broader questioning of the US currency’s role as a haven, against a backdrop of both policy uncertainty associated with the Trump administration as well as the nation’s fiscal outlook in the years ahead.
Of course, geopolitical risks still abound that show persisting demand for dollar assets in times of stress. The dollar briefly touched a three-week high on Monday as oil prices climbed following the Israeli and US strikes on Iran; Treasuries have also rallied alongside other global debt amid the Middle East tensions.
But the Wall Street analysts are more focused on enduring shifts in global capital flows over a longer time horizon.
“Generally the theme that’s linked to the cross-currency basis is: Are investors, particularly in Europe, repatriating money from the US?” Guneet Dhingra, the head of US interest-rate strategy at BNP Paribas SA, said in an interview. “Our view at BNP is that there is definitely a fair bit of cross-border flow, particularly from the US to Europe.”
At Goldman Sachs, Simon Freycenet and Friedrich Schaper argued that the unwind of the European Central Bank’s balance sheet will likely persist beyond the Federal Reserve’s own quantitative tightening efforts. Combined with Europe’s positive net international investment position — especially compared to the US, which is the world’s major international debtor — these dynamics should support the tightening of euro funding relative to the dollar over time.
“The modest currency base moves in the wake of ‘Liberation Day’ are notable, likely also reflecting the absence of a dash for dollars amid a more resilient global financial system than before,” Freycenet and Schaper said.
Goldman ultimately sees potential for the euro to become more expensive than the dollar in the cross-currency basis swap markets — a rare phenomenon over the last two decades.
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