Hi,I do study FX forwardsI now know that for example a 1Y FX FWD have an exposure to the 1Y USD LIBOR rate, the 1Y EUribor rate and the 1Y eur/usd basis.but I don t get what drives the moves of the basis.I understand why the euribor curve will go higher or lower depending on the macro economic data, same for usd libor.but what makes the basis go lower or higher ( especially what make them go on the opposite side as the currency curve for example basis up and euribor down??)if someone could help...I am a little bit confused.thx vm

Hi,The cross-currency basis spread is the measure of a couple of things: the relative credit-worthiness of the banks involved in setting Libor vs Euribor, the relative demand for cash funding in the two countries, and also the difference in credit risk of trading an FX Forward vs two deposits. e.g. at the moment EUR/USD basis is quite negative, a testament to the fact that the European banks are considered less credit-worthy than US banks (exposure to SIVs etc), but also due to their struggle to get hold of USD-denominated funding. It is quite difficult for them to borrow on an unsecured basis at the moment, so they can borrow on a secured basis from the ECB for term, then use the FX Swaps to convert the loan into Dollar funding (UK banks have also been seen doing this heavily, as a result of the BoE being reluctant to lend at non-penal rates - check out the 1yr EUR/GBP basis sprd on bbrg around the dates of the ECB 3m tenders: it spikes around each of them).In addition, in the current environment where Euribor-EONIA basis spreads have stayed much wider than Libor-FedFunds basis sprds, this has kept the cross-currency spreads negative. If you think about it, the Euribor-EONIA and Libor-FedFunds basis spreads effectively tell you what the domestic credit premia is for lending 3m vs over-night, so if one is wider than in the other country, then its banks are more risky for term-lending.At the moment, it is purely credit concerns that are driving Libor/Euribor, whilst the FX Forward (which has just the risk of the fxspot move on the principal vs loss of entire principal+interest in the case of a deposit), is more centred on overnight funding rates, and thus interest rate expectations.

Very good, insightful response cpulman, thank you.

Hi thereHow do you measure this basis below 1year where x-ccy are less liquid ? Lets take the EURUSD example which is oone of the most liquid currency pair .How do you work it out? With respect to what instrument?And then, how do you work out the basis below 3 month?The whole point of my question at the end of the day is to determine consistently a basis when you trade fx forward below 1year ..Thanks for the help !