Japanese banks and companies have nearly doubled their dollar-denominated debt issuance this year to the second highest on record as they seek to avoid the unusually high costs of raising dollars in other parts of the financial markets.
The yawning gap between dollar and yen "cross-currency basis", a consequence of diverging US and Japanese monetary policy as well as tighter banking regulation, was highlighted by the Bank for International Settlements (BIS) in its quarterly review last week.
"Cross currency basis" is effectively the cost of swapping one currency into another without the exchange rate risk and is a measure of the scarcity of one currency relative to the other.
In benign markets, there is virtually no premium for one currency over others in the FX basis market. But the premium for dollar funds has stayed stubbornly high this year.
If central bankers and market watchdogs are monitoring this niche area of financial markets, Japanese corporations are avoiding it, preferring to raise dollar cash by issuing bonds.
According to Thomson Reuters data Japanese firms raised $51.9 billion in dollar-denominated bonds this year up to September 20. That's up 88 percent from a year ago, the most for any comparable period since the $58.9 billion in 1989, and the second highest since records began in the 1970s.
Around two thirds of issuance has come from banks and other financial institutions, reflecting the sector's reliance on and exposure to dollar markets. Dollar-denominated issuance by European firms has also risen sharply, up 23 percent to $262 billion.
But the pressure is greater on Japanese institutions, which have higher dollar borrowing levels and therefore greater dollar funding needs.
This comes as the three-month dollar/yen currency basis is trading around -70 basis points, signifying a 70 bps premium for dollar funding over comparable yen borrowings.
The gap has been between -70 and -75 bps for the last few months, the widest for five years, and coincides with a broader rise in dollar funding and borrowing costs such as dollar London interbank offered rates (Libor).
"Unlike 2007, Libor spread widening this time around is not associated with systemic pressures. But a worry here, as seen in the widening of basis spreads, is that while markets are de-risking they are less able to channel liquidity efficiently," said Lena Komileva, head of G+ Economics, a consultancy.
Tighter post-crisis regulation in the shape of constraints on banks' balance sheets and reform to US money market funds that takes effect next month are pushing up dollar Libor and the cost of hedging foreign exchange risk.
Financial contracts worth trillions of dollars are tied to Libor. Libor and its premia over risk-free interest rates are often seen as a barometer of the health of the banking system.
There's no suggestion that the plumbing of the global banking system is getting gummed up like it did in 2007-08, when the complete seizure of lending precipitated the financial crisis and the worst recession since the 1930s.
But the Geneva-based BIS, often seen as a central bank to the central banks, noted that tighter regulation limiting banks' activity in derivatives markets, growing demand from market players to hedge their FX exposure and continued uncertainty over monetary policy all meant that the gaps could persist.
"Even in the absence of bank funding strains like those seen during the great financial crisis, a sufficiently high net demand for currency hedges could result in persistent deviations," the BIS said in its quarterly review.
The Fed has done nothing since last December, yet dollar Libor and the gap between Libor and the Fed's main fed funds interest rate are both the highest since 2009.
This effective tightening of financial conditions has put an extra squeeze on banks. Japanese and European banks have felt the strain more than most, their shares down nearly 30 percent and more than 20 percent so far this year, respectively.
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