Today I will discuss some recent developments in the foreign exchange market, and provide some views on the role of the Reserve Bank’s various policy measures. I will also briefly discuss a modest change to the way the Bank will be using foreign exchange swaps to manage our foreign exchange needs.
A novel development in the market for Australian dollar swaps
Typically, Australian banks pay a small premium to swap foreign currency into Australian dollars. This premium is also referred to as the basis, which is the difference between the implied cost of obtaining Australian dollars in the FX swap market and the cost of obtaining Australian dollars onshore. Most of the time the basis is positive, but over the course of 2020 the basis declined and became negative at shorter tenors, with a very noticeable decline around the turn of the year (Graph 1). I thought it was worth explaining what’s happened in this market.
But first, it’s helpful to understand why the Australian banks have typically paid a premium in this market. They obtain foreign currency by issuing debt offshore – including via bonds denominated in US dollars. They do this to help diversify their funding sources. It allows them access to deep, liquid foreign capital markets. They then swap this foreign currency into Australian dollars in order to fund their Australian dollar assets, including the loans they make to households and businesses.
Read More: FX markets around the turn of the year