Synopsis:

As equity markets tumble and volatility rises, ING is monitoring signs that broader financial stress may be brewing. One key indicator: the EUR/USD three-month cross-currency basis swap, which could signal USD funding stress.

Key Points:

• Defensive FX positioning dominates:
  With equity markets under pressure, liquidity and balance of payments strength are guiding FX flows. The US's ~4% current account deficit is a vulnerability as foreign investors may hedge more or pull capital.

• No clear “Sell America” move yet:
  Despite fears of policy-driven investor flight, there’s no broad underperformance in US Treasuries versus Bunds yet. However, sovereign CDS on the US rose 5bp and could worsen if demand weakens in this week’s Treasury auctions.

• EUR/USD basis swap as early warning:
  ING flags the three-month EUR/USD basis swap as a key barometer. If it widens sharply in USD’s favor, this could signal funding stress in the dollar and hint at broader market dysfunction.

• Wider credit concerns:
  US high-yield spreads are widening, and ING warns of potential hidden risks ("skeletons") in the system. This could trigger a shift from a political crisis to a financial crisis.

Conclusion:

While the USD is currently under pressure due to balance of payments risks and rising stagflation fears, ING cautions that dollar funding stress—as seen via the cross-currency basis swap—could flip the narrative. A sharp basis move may briefly strengthen the dollar, but also raise the likelihood of Fed intervention.