Key takeaways

• Since the start of the Covid-19 pandemic, indicators of dollar funding costs in foreign exchange markets have risen sharply, reflecting both demand and supply factors.

• The demand for dollar funding has grown in recent years, reflecting the currency hedging needs of corporates and portfolio investors outside the United States.

• Against this backdrop, the financial turbulence of recent weeks has crimped the supply of dollar funding from financial intermediaries, sharply lifting indicators of dollar funding costs.

• These costs have narrowed after central banks deployed dollar swap lines, but broader policy challenges remain in ensuring that dollar funding markets remain resilient and that central bank liquidity is channelled beyond the banking system.


Since the onset of the Covid-19 pandemic, indicators of dollar funding costs in foreign exchange markets have risen sharply, approaching levels last seen during the Great Financial Crisis (GFC).

One such measure is the so-called FX swap basis (or “the basis”), which is the difference between the dollar interest rate in the money market and the implied dollar interest rate from the FX swap market where someone borrows dollars by pledging another currency as collateral. A negative basis means that borrowing dollars through FX swaps is more expensive than borrowing in the dollar money market.

In tranquil times, the basis is close to zero, as an arbitrageur can exploit the basis and supply dollars in the FX swap market in order to pocket the difference. However, during periods when bank balance sheet capacity is scarce, the basis need not be squeezed to zero. In particular, a large negative basis reflects a scarcity of dollar funding. In recent weeks, the FX swap basis widened sharply, but then narrowed after the deployment of central bank swap lines, although it remains elevated for some currencies.

What is behind these moves? To understand recent events, it is important to consider both sides of the FX swap market – those wishing to obtain dollars and those willing to supply them. On the demand side, institutional investors (insurers, pension funds and other portfolio asset managers) play a key role. Such investors have obligations in domestic currency, but they hold a globally diversified portfolio, with a substantial portion denominated in the US dollar. To finance the purchase of dollar assets, they swap

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