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The Fed and dollar swap lines

Hi All,

I've been doing some reading on credit markets and the Fed's recent operations. Can anyone help unpack the below: I've bolded a few parts that I'm trying to better understand (particularly the final 3 bolded sections on FX swap lines, and the need to keep these lines funded and open. It comes from a quant/strategy desk.  Thanks!

The Fed’s liquidity injections appear not to be working.

All segments of funding markets – secured, unsecured and FX swaps – continue to show growing signs of stress. The Fed may have to do more still.

In the U.S., we watched, but didn’t feel the funding impact of large banks in other countries being asked to help their economies. Now that U.S. banks are asked to do the same, dollar funding markets are starting to feel the impact.

As U.S. banks increase their lending to the real economy as corporations draw on credit lines and banks lend more to households and firms, lending will consume more balance sheet and risk capital, and that will leave less room for market making and arbitrage, which under current circumstances are “luxury”.

The breakdown of o/n repo markets yesterday tell us that balance sheet is now getting scarce to conduct even the most basic type of market making.

As banks are pulling back from market making, the Fed and other central banks need to assume the role of dealer of last resort…

The Fed needs to become a buyer of CDs and CP, but not through the CPFF.

The Fed needs to offer dollars on a daily frequency through the swap lines, and other central banks need to lend dollars on to both banks and non-banks.

The Fed needs to broaden access to the swap lines to other jurisdictions as dollar funding needs are large in Scandinavia, Southeast Asia, Australia and South America, not just in the G-7. The dollar funding needs of both banks and non-banks is what’s at risk and the assets that are being funded are U.S. assets – Treasuries, MBS and credit – so the Fed has a vested interest.

A hallmark theme of the post-QE global financial order has been the secular growth of FX hedged fixed income and credit portfolios at non-bank institutions like life insurers and asset managers from negative interest rate jurisdictions – the new shadow banking system, epitomized by money market funding (FX swaps) of capital market lending (Treasuries and the full credit spectrum).

Carry makes the world go round and as banks do more for the economy central banks will have to backstop the shadow banking system – yet again…

What's your question specifically? The article is basically saying that, when liquidity dries up in the banking system Central Banks need to become the lenders of last resort. They need to become market makers because private firms don't have the confidence to do so....

"Pragmatic Capitalism is the best website on the Internet. Just trust me. Please?" - Cullen Roche

Specifically, can you elaborate on the necessity for the swap lines--i'm just trying to understand how the pieces connect. Every major country needs access to immediate US dollars because of safety, or is that they need to sell their currency to get US for debt commitments? Why are dollar funding needs so large in other jurisdictions, and hence why does FED need to broaden these lines?

Is it that large swathes of financial institutions around the world (central banks, bank, and non-bank entities) load up on treasuries, hence they need to convert their currency into USD pursuant to the swap facility?

The Fed needs to broaden access to the swap lines to other jurisdictions as dollar funding needs are large in Scandinavia, Southeast Asia, Australia and South America, not just in the G-7.

Hi @alexv,

Sorry for the slow response. CRAZY TIMES!

Many foreign banks make loans denominated in USD. When they do this they need to support that lending by sourcing the actual underlying dollars. They usually source those dollars from their own central bank.

In environments like the current one the foreign Central Banks will often buy USD to try to support their domestic demand for USD and that can cause volatility in the US economy by driving up the dollar and making the dollar appear artificially strong. The Fed offsets this by proactively lending USD via currency swaps. This eases pressure in the dollar market.

Does that make sense?

"Pragmatic Capitalism is the best website on the Internet. Just trust me. Please?" - Cullen Roche