Recent Developments in U.S. Dollar Funding Costs through FX Swaps

Since the summer of 2011, foreign exchange (FX) swap-implied U.S. dollar rates have attracted attention amid a growing concern over European banks' dollar funding. In this paper, we analyze the dollar rate based on interest arbitrage and clarify the factors affecting its fluctuation. The main results of the analysis are as follows. (1) From mid-July to late October 2011, the FX swap-implied dollar rate from the euro rose under increasing stress observed in the unsecured euro and dollar markets. (2) From November, the rate soared to a level not fully explained by the observed stress in the unsecured markets, implying a very tight dollar funding situation in the FX swap market. (3) Subsequently, the rate started to decline and showed that stress in the FX swap market had eased, as the year-end had passed without a problem given the coordinated central bank action to lower the interest rates on the dollar funds-supplying operations.