James Luke_ Lee#91

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What is the cross-currency basis and why does it matter?

The cross-currency basis is the deviation between theoretical forward pricing (based on interest rate parity) and actual FX swap market pricing. A negative basis implies USD funding is scarce—borrowers must pay extra to swap into dollars. For example, in 2008 and 2020 crises, cross-currency bases widened sharply, signaling stress. Institutions track the basis as a key systemic risk indicator, reflecting dollar liquidity demand globally. For traders, basis shifts explain why forward points or swap costs sometimes diverge from expected interest differentials. Retail traders rarely trade basis directly, but it affects rollover charges and market sentiment. Monitoring basis spreads gives insights into hidden funding stress, useful for anticipating volatility.