Dollar Basis Hints at Weakening Appetite for Treasuries

(Bloomberg) -- The premium the dollar commands in currency derivatives is nearly gone, an indication that foreign demand for US debt is weakening.

The dollar’s weighted-average three-month basis against five major peers, which reflects the premium or discount investors accept to borrow one currency against another, is just below three basis points, according to data compiled by Bloomberg. It is now on track to turn negative for the first time since August 2020.

The cross-currency basis market gauges how much it costs to exchange one currency for another beyond what is implied by borrowing costs in the cash markets. The basis effectively sets the price of foreign-exchange hedging for global investors; it’s also an indication of flows between economies and asset classes.

For decades, dollars taken in by countries that have trade surpluses with the US have often been directed into Treasuries. Demand for currency-hedged bond holdings has helped sustain dollar premiums. But the share of Treasuries held by foreign investors has slid to 33% of the amount outstanding, from a peak of 52% in 2012, data compiled by Bloomberg shows.

Concerns about US fiscal policy and tariffs under Donald Trump’s presidency have contributed to a “sell America” narrative taking hold in some areas of the markets in recent months.

“Weaker foreign demand for Treasuries at longer maturities can be a contributing factor” for the fading dollar premiums, said Naokazu Koshimizu, a senior rates strategist at Nomura Securities Co. in Tokyo.

To be sure, global investors boosted holdings of Treasuries to a record in June, Department of the Treasury data show. But they represent a declining share of the overall market, as foreign investors increasingly look to park their money elsewhere.

In the US, Wall Street analysts are also increasingly focused on the cost of funding in the market for repurchase agreements as the Treasury rebuilds its balance sheet following the resolution of the debt ceiling debate earlier this year. A rise in repo rates will make dollar funding more expensive, they argue, in turn driving the dollar’s premium in the basis markets higher, not lower.

“Dollar repo rates are set to rise in coming months, pressuring front-end euro cross-currency wider,” a Wells Fargo team including Jack Boswell and Erik Nelson wrote in a Friday note.

Still, a factor that’s possibly narrowing dollar premiums is a relative difference in liquidity across economies and prospects for Federal Reserve interest-rate cuts, according to Mizuho Securities Co.’s Hidehiro Joke.

Central banks outside the US are trimming their balance sheets, which reduces liquidity and may raise premiums on non-dollar currencies. At the same time, any Fed rate cuts could narrow dollar premiums.

--With assistance from Carter Johnson.

(Updates to include latest market commentary on cross-currency basis.)

More stories like this are available on bloomberg.com

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