Dollar hoarding: It’s hard to let go

When I think of dollar hoarding, one episode really stands out for me. It was during the Russian crisis in late 2014 when Russian corporates were reluctant to sell their USD export earnings back into the local FX market. This USD hoarding was sending USD/RUB through the roof until some local moral suasion was used to encourage Russian exporters to offload their dollars for roubles.

But a quick Google search for ‘dollar hoarding’ now typically delivers references to events in March this year when a funding squeeze drove the dollar higher. At the time corporates were being blamed for the move as they sought access to precautionary stockpiles of dollars ahead of expected supply chain disruptions. The Financial Times lent some support to the story with reports that corporates had drawn down US$124bn from their bank credit facilities in the last three weeks of March – a time when a traditional supply of USD funding – the Commercial Paper market – had seized up.

Trying to pin down this hoarding activity in terms of data is a challenging task

ING’s Markets team wrote a lot on this subject at the time and in addition, this BIS paper delivers some useful analysis of this issue – especially on some of the key protagonists on both the supply and demand side of the dollar funding story. On the demand side of the dollar funding equation, there is a myriad of dollar users as a result of the currency's dominance in trade and financial flows. In addition to corporates, there is large buy-side demand for dollar funding to hedge USD-exposed diversified portfolios. And, of course, banks play a major role here – European banks’ dependence on the wholesale markets to fund USD loan books had been a major source of distress in 2008.

Trying to pin down this hoarding activity in terms of data – and what it means for the dollar in general – remains a challenging task. But we think we’ve found a few clues.

If the narrative of dollar hoarding plays out, USD deposits should show up somewhere. Where better to look for those USD deposits than from the banks, which report changes in deposit liabilities to their local supervisors. For the eurozone banking sector, ING’s Teunis Brosens routinely analyses the monthly ‘Monetary Developments in the Euro Area’ release from the ECB. Here it seems that some of this dollar hoarding activity may have emerged in the March publication.

Teunis’s chart below shows how euro area banks have seen their deposit liabilities surge by close to EUR1trn in 1Q20. This is the largest quarterly increase on record. Well over half of that is in euros and reflects local liquidity hoarding by banks, corporates, and financials. The stand out for us in this chart is the increase in USD deposit liabilities reported by Euro area banks – at almost EUR300bn. This well exceeds the prior record increase of EUR240bn also seen at the time of a major dollar funding squeeze in 2008.

Looking at where those USD deposits derived from, the ECB data shows a roughly 60:40 split in favour of eurozone over non-eurozone residents. Also, look at the dollar performance during this period – stress and the large build-up of deposits have typically been associated with a stronger dollar. This supports claims for the dollar to be the world’s only true funding currency.

In addition, the ECB data disaggregates these USD deposits into bank versus non-bank lenders. Was it all corporates preparing for supply chain challenges or more the banking community driving the rise in USD deposits? The data suggest that banks accounted for two-thirds of the rise in USD deposits (about EUR185bn). That still means that non-banks, including corporates, grew their USD deposits at Euro area banks by over EUR100bn in 1Q20. But we suspect that the narrative of corporates drawing USD via bank credit lines – and paying anywhere up to 1.00% p.a. for the privilege – may not be the key driver here.

Instead, we suspect that the euro area banks’ use of the Fed’s USD swap lines is driving the show. Eligible counter-parties can secure USD funding via seven and 84-day swap facilities, auctioned by the ECB. By the end of March, the ECB had lent out around US$100bn to euro area banks through these Fed swap lines. And it may be the use of these Fed USD swap lines that provides the most timely signals for the precautionary dollar funding story.

If the use of the Fed USD swap facilities could be the key driver of the USD deposit swing, then the good news is that data on its use is made available in a timely manner by the Fed. Currently, 14 central banks have access to the Fed’s USD swap facility, borrowing a current total of US$447bn.

There is a view that these precautionary dollars stay held into 2021 as banks wait to see the level of bankruptcies (our credit team sees 10-12% default rates in the European High Yield arena versus 6% priced by spread indices) or wait for a second wave of Covid-19. That caution makes sense and certainly, there are no signs as yet from the Fed data that banks are prepared to let their USD borrowing roll-off.

However, the total amount now borrowed from the Fed is not far off the peak use of Fed dollar swap lines in December 2008 – then at US$580bn. Somewhat surprisingly those dollar swap lines were wound down to zero by the end of 2009 – by which time the Broad Dollar Index had fallen 15% from its highs. Currently, the Broad Dollar Index has only fallen about 5% from its March 2020 peak.

We will now certainly be adding the use of the Fed’s USD swap lines to our toolkit. Any signs that banks are prepared to let their precautionary USD borrowing roll-off would add weight to our preferred view of more normalised conditions, a return of portfolio flows to emerging markets, and a benign dollar decline leading EUR/USD to 1.20 by year-end.