Dollar strength will linger

By Mansoor Mohi-uddin

Published: March 4 2009 16:06 | Last updated: March 4 2009 16:06

The inability of non-US banks to roll over short term funding of investments in illiquid US assets has been a key factor behind the dollar’s strength since last summer – and should continue to support the greenback, says Mansoor Mohi-uddin, managing director of foreign exchange strategy at UBS.

“At the height of the credit bubble in mid-2007, the Bank for International Settlements estimates that major European banks’ dollar funding needs was around $1,300bn,” he says.

“As the credit crunch ensued and then worsened after the bankruptcy of Lehman in September 2008, securing this funding became very difficult due to the severe disruptions in interbank and foreign exchange swap markets and in money market funds.

“Also, some central banks withdrew dollar foreign exchange reserves they had placed with commercial banks before the crisis.”

Mr Mohi-uddin notes that to ease the dollar shortage, the Federal Reserve provided swap lines with other central banks in October 2008. These have been extended until October this year, reflecting the need of foreign banks to keep borrowing dollars from domestic central banks.

“Of course, foreign banks also bought dollars in the spot markets, as evidenced by the drop in euro/dollar since last summer.

“While the dollar funding shortage in global banking persists, investors in the foreign exchange spot markets should expect the greenback to stay supported against the other majors.”