VINCENT CIGNARELLA: Important Funding Indicator To Watch

Not all the euros borrowed through the ECB LTRO program were placed on deposit with the European central bank. The 3-month and 1-year EUR/USD basis swaps have begun to decline, an indication banks have used some of the cheap euros to swap into dollars. The demand for dollar funding may indicate a trend of a market seeking dollars as a safe haven given rising tensions in the Middle East. If true, and the trend continues, two things will happen, the dollar will get decidedly stronger and dollar funding strains will increase for European banks as measured by the 1-year basis swap. The result will be an ECB putting its banks in a liquidity trap, borrowing variable and investing fixed in a rising interest rate environment; a bad carry trade.