Negative Cross Currency Basis Swap - By JP Morgan

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Dudeinthecity24

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I’m reading an article about high yield debt and active issuence of european corporates issuing debt in the US.
Can someone explain what they mean by bold statement below:
“we expect active issuance to continue due to: increasing funding diversification by EU issuers, the great depth of the USD market and a persistently negative cross currency basis swap?
What do they mean by that?
 
Probably that the rate on a cross-currency swap is negative (versus a normal positive rate) to the LIBOR party due to negative short term rates seen recently, a recent phenomenon due to the payments due cash versus bonds to the ECB for holding assets. Hope you reveiwed your swaps before the recent level 2 exam…
 
JSobes wrote:
Probably that the rate on a cross-currency swap is negative (versus a normal positive rate) to the LIBOR party due to negative short term rates seen recently, a recent phenomenon due to the payments due cash versus bonds to the ECB for holding assets. Hope you reveiwed your swaps before the recent level 2 exam…
Click to expand...
If you build the swap rate using LIBOR, I don’t recall LIBOR being negative? what I think they are saying is that after taking into account fx, issuing debt in USD is cheaper than using the Euribor, hence the negative basis.
Anyone! Please correct me if I am off here.
 
A standard CCBS is a float-float between USD and any other currency (say EUR in your case). When we say where is 10y EUR-USD CCBS trading, we are referring to the spread that is added to the non-USD side - say x bps to EURIBOR.
As you know the pricing is based on zero NPV at the start for both legs, so given the forward curve for both currencies, we want to calculate what shall we add to the EUR side, so it equals USD side.
Conventionally, that spread has been +ve (however not necessarily) but recently the steepness on the long end part of the EUR curve means, for long dated CCBS, it is negative to equate it with USD leg.
The way CFA curriculum covers derivatives pricing is completely out of date, its overly simplifies and had some validity before recession but certainly not afterwards due to use of OIS curves for discounting rather than LIBOR (and other changes)
Level two said, at every cash flow settlement date, float rate leg trades at par - thats not correct.
Lastly, “If you build the swap rate using LIBOR, I don’t recall LIBOR being negative?”, short end of the CHF and some of the scandinavian currencies has been negative for a few months. So its plausible, because it is relatively recent (not quite, happened around 2 years ago for the first time) phenomenon CFA curriculum doesn’t cover it.
 
Mission 2013-16 wrote:
A standard CCBS is a float-float between USD and any other currency (say EUR in your case). When we say where is 10y EUR-USD CCBS trading, we are referring to the spread that is added to the non-USD side - say x bps to EURIBOR.
As you know the pricing is based on zero NPV at the start for both legs, so given the forward curve for both currencies, we want to calculate what shall we add to the EUR side, so it equals USD side.
Conventionally, that spread has been +ve (however not necessarily) but recently the steepness on the long end part of the EUR curve means, for long dated CCBS, it is negative to equate it with USD leg.
The way CFA curriculum covers derivatives pricing is completely out of date, its overly simplifies and had some validity before recession but certainly not afterwards due to use of OIS curves for discounting rather than LIBOR (and other changes)
Level two said, at every cash flow settlement date, float rate leg trades at par - thats not correct.
Lastly, “If you build the swap rate using LIBOR, I don’t recall LIBOR being negative?”, short end of the CHF and some of the scandinavian currencies has been negative for a few months. So its plausible, because it is relatively recent (not quite, happened around 2 years ago for the first time) phenomenon CFA curriculum doesn’t cover it.
Click to expand...
So if I were a corporate in Europe, and needed to issue debt in US, I would look at the CCBS as see which is spread is better for me.
So if the spread is negative because the long end of the curve is higher in EUR than in USD making the coupon negative, I would want to issue in USD?
 
JSobes wrote:
Probably that the rate on a cross-currency swap is negative (versus a normal positive rate) to the LIBOR party due to negative short term rates seen recently, a recent phenomenon due to the payments due cash versus bonds to the ECB for holding assets. Hope you reveiwed your swaps before the recent level 2 exam…
Click to expand...
Can you expand on what you mean by “ a recent phenomenon due to the payments due cash versus bonds to the ECB for holding assets.”
I dont know how this would make the spread negative?
 
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