Swapping Places

What can we learn from the Fed’s swap lines?

Back in November the Fed made it easier for foreign central banks to borrow dollars. The European financial crisis was intensifying, and the Federal Reserve wanted to be sure that Societe Generale and Deutsche Bank didn’t fail because they ran out of dollars. But the Fed wasn’t going to lend to them—that was the European Central Bank’s job. So they expanded their swap lines with the world’s major central banks to allow them to borrow dollars from the Fed to lend to their own banks.

Currency swaps are pretty straightforward. The counterparty sells the Fed foreign currency in exchange for dollars at the prevailing market rate, while simultaneously buying them back at a specified rate in the future. That way the Fed isn’t taking foreign exchange risk; they’re taking credit risk, assuming the counterparty will be there in the future to buy their currency back. In the meatime, the Fed has the Euros as collateral, and those are exposed to currency risk only if the counterparty fails.

This is something the Fed also back in 2008, and swap balances soared—from nothing to almost $600 billion. As that crisis eased the swap holdings also went back to zero. In December last year the balances also grew, to just over $100 billion. It remained at that level until March, and has been steadily falling for the last six weeks. Currently they’re about $32 billion.

This tells us that liquidity pressures on foreign banks are easing. The swap facilities didn’t increase the global money supply, and so global prices didn’t like they did in late 2010. Foreign banks may need more capital in the long run, but they’re not facing imminent failure. If they were, we’d see it in the data.

Douglas R. Tengdin, CFA
Chief Investment Officer
Hit reply if you have any questions—I read them all!

Follow me on Twitter @GlobalMarketUpd

direct: 603-252-6509
reception: 603-224-1350

www.chartertrust.com • www.moneybasicsradio.com • www.globalmarketupdate.net

Leave a Reply

Your email address will not be published. Required fields are marked *