Why Borrowing in Dollars Sometimes Costs More Than the Headline Rate

Start With a Simple Swap

Imagine two businesses that each need the other's currency for a while. One has dollars and needs euros; the other has euros and needs dollars. They agree to trade now and trade back later at a price fixed today. That is essentially an FX swap, and it is one of the oldest, most practical tools in global finance.

The Bank for International Settlements describes an FX swap as a contract where one party borrows one currency and simultaneously lends another, with the repayment amount fixed at the forward rate agreed at the start. Because the exchange is locked in, an FX swap works like collateralised borrowing and lending with the currency risk taken out of the picture. It is funding, not a bet on where the exchange rate will go.

These swaps are most liquid at maturities under a year, though longer deals have become more common. Banks, exporters, importers and investors use them to raise foreign currency or hedge positions they already hold.

Where Forward Points Come From

When you swap currencies, the difference between the spot rate today and the forward rate later is quoted as "forward points." If you have ever seen a currency forward priced as a small number of pips rather than a full exchange rate, that is what you were looking at.

In theory, forward points should simply reflect the interest rate difference between the two currencies. If dollars earn more than euros, the forward price adjusts so that borrowing in one currency and swapping into the other costs the same as borrowing directly. This relationship is called covered interest parity, or CIP. Economists sometimes describe it as the closest thing international finance has to a physical law.

Here is the intuition. Suppose you can borrow dollars directly at one rate, or borrow euros and swap them into dollars. If the swap market were perfectly efficient, both routes would cost the same. If one route were cheaper, sharp-eyed traders would pile in until the gap closed.

The Basis: When the Law Bends

Since the global financial crisis of 2007–08, that tidy relationship has not held perfectly. The gap between the two funding routes is called the cross-currency basis. In plain terms, the basis tells you how much extra, or less, it costs to borrow a currency through the swap market compared with borrowing it directly in cash.

For most currencies against the US dollar, notably the euro and yen, the basis has been negative for years. That means borrowing dollars through FX swaps has been more expensive than borrowing dollars directly. For some currencies, like the Australian dollar, it has run positive.

Why doesn't arbitrage close the gap? The BIS points to two forces working together. First, there is heavy, persistent demand for dollar hedges from banks, pension funds, insurers and companies that issued debt in foreign currencies. Second, the traders who would normally arbitrage the gap face real constraints: balance sheet costs, capital rules and risk limits mean they cannot simply pile on positions for free. As the BIS puts it, balance sheet space is rented, not free.

Who Is on the Other Side?

The direction of the basis depends on who needs which currency. In Japan, banks with surplus yen deposits compete with domestic institutional investors to borrow dollars through swaps, pushing the dollar basis negative. In Australia, banks with big domestic mortgage books lend dollars in the swap market, offsetting investors' hedging demand and pushing the basis positive.

Corporate bond issuance matters too. When US companies found it cheaper to issue in euros and swap the proceeds into dollars—so-called reverse yankee bonds—that added to hedging demand and coincided with a wider euro-dollar basis.

One gentle observation: currency hedging demand is a bit like traffic. Everyone leaving at once creates a jam, and the toll road (in this case, the swap market) charges more when the queue is long.

Cross-Currency Swaps: The Longer Cousin

FX swaps typically cover short periods. Cross-currency swaps stretch the same idea over years, with periodic interest payments in each currency and a final exchange of principal. The BIS notes that most cross-currency basis swaps run between one and 30 years, matching the long-term investments or liabilities they fund.

The pricing works similarly. One leg carries a small spread—the basis—that makes the swap fair at inception. When the basis is negative, one party effectively pays a premium to borrow dollars through the swap rather than in cash. When it is positive, they get a discount.

Valuing these swaps requires discounting cash flows in each currency on the appropriate curve, converting at the spot rate, and including the basis spread. Ignoring the basis produces the wrong value—a point specialists make emphatically.

Why It Matters Beyond the Trading Desk

For an ordinary saver or borrower, the basis rarely appears by name. But it shapes real outcomes. It affects the cost for a multinational hedging foreign profits, the yield a pension fund earns on hedged overseas bonds, and the price a central bank pays to provide dollar liquidity in a stress episode.

During the 2008 crisis and again in 2020, the cost of borrowing dollars synthetically through swaps spiked, showing how quickly funding stress can travel across borders. A negative basis is not a malfunction; it is a signal that demand for one currency's funding is outstripping the market's willingness to supply it at the textbook price.

It is worth being clear about what this does not tell you. A wide basis is not a prediction, a trading signal or a guarantee that one currency will strengthen or weaken. It is a price—a snapshot of supply and demand for funding at a moment in time.

Rules, market structure and data availability also differ by jurisdiction, so the same headline basis number can mean slightly different things depending on where and how it is measured. Anyone using it for decisions should check the conventions and the specific market.

The Takeaway

Forward points look like a technical detail, but they carry real information about who needs which currency and how easily the market can meet that need. When funding imbalances build and arbitrage is constrained, the basis widens—and the price of moving money across borders quietly changes. Understanding that link turns a cryptic number into a useful lens on global finance.