BASIS: Swap Spreads Key To Swings In X-ccy Basis, USD Premium Vs. EUR Vanishes

Recent moves in EUR/USD x-ccy basis saw many tenors trade in positive territory, as the USD lost its premium vs. the EUR.

• The general train of thought suggests that tighter U.S. regulation and the related lack of meaningful financial intermediation in the post-GFC world promoted the USD premium “norm” established in x-ccy basis in recent years. So the natural question is what drove the recent move?
• Long end EUR/USD x-ccy basis is particularly correlated to swap spread differentials, which traded further above 0 relative to the 6-month tenor.
• EUR swap spread tightening has made EUR issuance less attractive for USD-based issuers, removing latent demand to swap EUR into USD.
• Meanwhile, USD issuance from EUR-based issuers has continued to tick over, maintaining latent demand to swap USD into EUR.
• On net, this presents pay-side demand for x-ccy basis
• Note that the recent stabilisation/widening from lows in EUR swap spreads has coincided with a pullback from highs in x-ccy basis spreads, adding further weight to the correlation outlined above.
• Also note that some sell-side names have suggested that dealers’ gamma positioning may have fed into the sharp move higher in long end EUR/USD x-ccy.

Fig. 1: EUR/USD 3m, 6m, 1y, 5y, 10y & 30y Cross-Currency (X-ccy) Basis