Are domestic US dollars starting to tighten?

In the past few days, the USDCNY short-end swap points have been steadily falling, and after the quarter-end rollover, the tightness in USD liquidity still hasn’t eased. In a single day, the overnight swap points dropped to below -6 pips. The usual USD funding providers have also started to be reluctant to provide dollars, indicating that onshore USD funding is tight.

On Thursday, the lowest onshore USDCNY O/N swap points fell to -6.5 pips. Based on the RMB overnight DR001 rate of 1.26%, the implied USD overnight interest rate was as high as 4.67%, nearly 100 bps higher than the overnight SOFR rate of 3.68%.

Why did the USD suddenly start to feel tight?

Dollars are being used to buy U.S. Treasuries

Since last year, as domestic yields have continued to be compressed, financial institutions have been increasing their investments in overseas bonds. Given the current overnight USD interest rate, buying 10-year U.S. Treasuries yielding above 4% is a very attractive carry-and-coupon-stripping strategy.

From the PBOC’s published financial institutions’ foreign exchange credit and funding statement, it can be seen that the bond investment item has increased by more than $100 billion since July 2025. Among them, net additions of $39.3 billion occurred in January this year; it dipped slightly in February. The March figure has not yet been released, but with global government bond yields having risen sharply in March, many institutions may have added to their positions.

Onshore FX reserve inflows increase, onshore USD funding pool decreases

Since December last year, onshore corporates’ FX settlements have surged. How does corporate FX settlement affect onshore USD liquidity? You need to distinguish between two scenarios:

Corporates sell USD via FX settlement → commercial banks passively buy USD →

1）If FX reserve inflows are unchanged, then the overall USD funding pool in the banking system remains unchanged;

2）If FX reserve inflows increase, then the USD funding pool in the banking system decreases.

Since this year, FX reserve inflows have increased by 137.2 billion RMB, about $20 billion, creating a pumping effect on onshore USD.

Offshore USDCNH swap points drive

In the past few days, in the offshore market the short-end swap points for USD/CNH have been consistently below the onshore USD/CNY. On the TN of USDCNH across the end of March for a single day at -6 pips, CNH funding has also been unusually loose. Based on the 3.68% overnight USD SOFR rate, the implied CNH overnight rate was only 0.55%. The decline in offshore swap points has also caused some perturbation to onshore swap points.

Wariness and risk-off sentiment lead to some tightness in global USD liquidity

We usually use the cross-currency swap basis (Cross-currency Swap Basis, CCS basis) to gauge how scarce overseas USD is. Non–non-USD institutions can convert their local currency into USD via FX SWAPs or CCS to use USD. The sign and size of the basis directly reflect how high or low the conversion cost is. Looking at 1-year swap basis for other currencies (euro, yen), by the end of March overseas USD was also showing a certain degree of tightness. However, after the end-of-month rollover in April, liquidity recovered somewhat.**

Overall, taking a look at this year’s onshore swap market compared with last year, it can be described as like ice and fire in the same season. Last year, dollars were very loose when rolling across months and quarters, but this year USD has turned tight. The author believes there are mainly four factors jointly driving it: the outflow of dollars used to buy bonds, the increase in the PBOC’s FX reserve inflows, the fall in USDCNH swap points, and the tightening of global USD liquidity triggered by the war.

However, at present overall overseas USD liquidity is still relatively abundant, and related liquidity indicators have not shown any clear early-warning signals. If geopolitical conflicts ease later and risk-off sentiment is repaired, it is expected that onshore USD liquidity will improve in sync with offshore liquidity.

Source of this article: Good Morning FX Market

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