Money-Market Stress Seen Avoiding Crisis Level on Russia Risk

(Bloomberg) -- Gauges of money market stress remain elevated after hitting their highest since 2020, though bank strategists don't see the turbulence escalating into a full-blown crisis.

While distortions in funding markets have eased since Monday, the cost of converting euro payments into dollars using one-year cross-currency basis swaps is still around the most expensive since March 2020. Traders are weighing the fallout of sanctions on Russia against the backstop from central banks.

“The latest sanctions are felt among banks and in dollar funding markets,” said Christoph Rieger, head of rates research at Commerzbank AG. “Importantly, however, markets are functional at these more expensive levels, seeing the Russian financial market risks as ring-fenced and not as systemic.”

Much of the stress boils down to uncertainty over how important a cog Russia was in the plumbing of the global dollar system. That's hard to determine, depending on the degree to which they have been providing dollars into currency swap markets, according to Blake Gwinn at Royal Bank of Canada, who doesn't think they were a major player.

Credit Suisse AG put it at $300 billion, when including currency swaps and foreign bank deposits. The decision to exclude various Russian lenders from the SWIFT messaging system could result in missed payments and giant overdrafts within the international banking system, according to strategist Zoltan Pozsar. Drawing comparisons with the 2008 Lehman Brothers failure, he said central banks should be ready to intervene.

In any case, market participants know there are better safeguards in place than during previous shocks. Some swap lines between the Federal Reserve and major central banks are still in place, while a new repurchase agreement facility for foreign and international monetary authorities, known as FIMA, could help alleviate pressures in global dollar funding markets.

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“While the program applies an above-market rate, it enables these institutions to monetize their Treasury holdings without having to sell them,” said Barclays Plc analysts including Joseph Abate. “Similarly, the Fed's longer-term central bank swap lines can be re-activated to extend term secured funding to non-US central banks.”

One-year euro-dollar basis -- which isn't prone to year-end effects -- traded around minus 31 basis points Tuesday. The gap between future Libor and Fed rates, a gauge of funding stress known as the FRA/OIS spread, tightened to around 18 basis points for one-month contracts.

“The funding market is likely to be impacted by FX swap exposure and private sector deposits. While we estimate the exposure to be large, of the order of $300 billion, the counterparty linkages should be much less complex than Lehman,” said Mohit Kumar, a rates strategist at Jefferies. “Both the U.S. and European banking system would be in a much better position to counter any funding stress with central bank liquidity and fx lines operations.”