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The economic fallout from the COVID-19 crisis has led to stress in US dollar funding markets over the past few weeks, reflecting both demand as well as supply side factors. US dollar funding demand has grown in recent years due to currency hedging by corporates, banks and portfolio managers outside of the United States (the US). It is likely to increase further as demand from EM countries’ corporates and financial institutions should increase with pandemic-related lockdowns, supply chain disruptions and economic strains.
The FX swap basis is the difference between the dollar money market interest rate and the implied dollar interest rate in the FX swap market, where US dollars are borrowed against another currency as collateral. A negative basis would mean borrowing dollars through FX swaps is more expensive than borrowing from the dollar money market. This also makes it dearer for international investors to hedge US dollar exposure owing to the impact on the pricing of forward foreign exchange.