Federal Reserve to announce a major expansion of its "swap" lines with other central banks, which allow them to provide liquidity in dollars to their local commercial banks. The Fed now has arrangements with nine other central banks, which together provide access to a total of $620 billion.
Still, that hasn't been enough to ease the squeeze. Some of the demand for dollars has spilled over into the currency markets. There, participants can buy dollars outright, or use derivatives known as currency swaps to exchange one currency for another at two different points in time.
Some investors say the appetite for dollars is akin to the demand for the yen. The yen surged against the dollar and the euro Monday; late in New York one dollar bought 101.61 yen, down sharply from 105.14 Friday.
The yen's ability to thrive stems from the fact that in better times, investors borrow in yen to take advantage of Japan's ultralow interest rates. But when volatility rises or investors need to cover losses elsewhere, they undo these maneuvers -- known as carry trades -- and buy back yen, boosting Japan's currency.
Meanwhile, by borrowing so much in dollars, foreign banks may have created "the biggest carry trade of all time," says Hans-Guenter Redeker, a currency strategist at BNP Paribas in London.
The U.K. pound was at $1.7465 from $1.7752, and the dollar was at 1.1476 Swiss francs from 1.1274 francs Friday.
European banks appear particularly affected by the dollar squeeze. In a June report, the Bank for International Settlements noted that in recent years European banks had borrowed short-term in dollars from other banks and channeled those funds into longer-term credit for nonbanks -- one such example could be mortgage-related investments in the U.S. The net liabilities to all banks grew to more than $800 billion by the end of last year.
Since the collapse of Lehman Brothers Holdings, it has become very difficult for European banks to raise dollars in the U.S. money markets. In particular, money-market mutual funds that are large providers of cash have turned cautious. Many will only part with their cash for a day at a time and restrict their lending to the strongest companies and large U.S. banks.
Several mornings over the past few weeks, traders reported that some European banks that needed to borrow U.S. dollars had difficulty finding investors to lend them cash overnight, even if the banks paid rates of more than 6%. When evenings came, money-market funds would rush to invest billions of dollars in overnight dollar deposits with large U.S. banks, in some cases accepting interest rates of as low as 0.01%.
