Cash-rich Japanese banks are paying almost as much extra to borrow dollars on the currency swaps market as they did when they were fighting for survival two decades ago, due to their insatiable appetite for higher-yielding dollar assets.
Instead of buying dollars in the currency markets, Japanese banks and investors can get dollars by swapping yen loans into dollars using these over-the-counter derivatives instruments, thus avoiding currency risks, CNBC reported.
But pricing of the swaps, which in the 1990s was inflated by the mountain of non-performing assets on Japanese banks' books, is now being driven mostly by demand for dollars to fund an overseas investment binge. The cost of swapping yen to dollars for five years has risen to a two-year high of 73.5 basis points, a level historically recorded only at times of strong financial stress.
The swap spread had been shrinking since late 2011 when six major central banks halved interest rates on their dollar swap agreements in late 2011 to 50 basis points to deal with market stress during the eurozone crisis.
But the spread started rising in the middle of last year even as spreads for other currency pairs such as euro/dollar remained largely stable. The steady rise in the cost of swapping yen to dollars reflected Japanese investors' stampede into foreign assets, especially high-yielding dollar assets.
"Because returns on domestic products are so low, foreign-currency-denominated stocks and bonds are popular among Japanese investors. Their need for dollar funding is pushing up the cost," said Makoto Noji, senior fixed-income strategist at SMBC Nikko Securities. In 2014, they bought 12.1 trillion yen ($98 billion) of foreign securities after net sales of six trillion yen in 2013.
