The Federal Reserve has set up emergency currency swap arrangements with central banks around the world to allow dollar-based lending to continue, with markets coming under increasing pressure as the CCP virus crisis unfolds.
The swap facilities allow the Fed to exchange U.S. dollars for foreign currency, enabling central banks abroad to provide dollars for financial institutions that trade in or lend U.S. dollars.
Reece said that the Fed is encouraging banks to borrow at the discount window, which means borrowing directly from the Federal Reserve, thus creating more reserves and providing liquidity—which was one of the original purposes of the Federal Reserve.
“Measures taken to flatten the virus spread curve (so as not to overwhelm healthcare systems) are creating extreme short-term economic strain,” Reece told The Epoch Times. “And that’s putting a lot of stress on the global financial system. Financial conditions will be the primary concern of the Fed over the next several weeks. Commercial paper and bank credit lines may be heavily relied on for businesses to continue making payroll, rent, supplier, and debt service payments, among others, while revenues are down.”
Fed Supporting Central Banks
The Fed issued a statement on the issue, which said, “The Federal Reserve on Thursday announced the establishment of temporary U.S. dollar liquidity arrangements (swap lines) with the Reserve Bank of Australia, the Banco Central do Brasil, the Danmarks Nationalbank (Denmark), the Bank of Korea, the Banco de Mexico, the Norges Bank (Norway), the Reserve Bank of New Zealand, the Monetary Authority of Singapore, and the Sveriges Riksbank (Sweden).”The liquidity facilities will allow central banks in Australia, Brazil, Korea, Mexico, Singapore, and Sweden to access up to $60 billion, while the central banks of Denmark, Norway, and New Zealand can avail of up to $30 billion. The credit swaps will be retained for at least 6 months. The Fed also has existing swap lines with central banks in Canada, the UK, Japan, and Switzerland, as well as with the European Central Bank.
The Fed said that the so-called liquidity arrangements “are designed to help lessen strains in global U.S. dollar funding markets, thereby mitigating the effects of these strains on the supply of credit to households and businesses, both domestically and abroad.”
Fed Seeks to Shore Up US Lending
The Fed also introduced the Money Market Mutual Fund Liquidity Facility, or MMLF (pdf), this week. It will allow the Federal Reserve Bank of Boston to “make loans available to eligible financial institutions secured by high-quality assets purchased by the financial institution from money market mutual funds.”According to the Fed, such “[m]oney market funds are common investment tools for families, businesses, and a range of companies.”
“The MMLF will assist money market funds in meeting demands for redemptions by households and other investors, enhancing overall market functioning and credit provision to the broader economy,” it said.
In effect, the MMLF will help money market funds to trade commercial paper, treasuries, and bonds that are guaranteed by mortgage lenders Fannie Mae and Freddie Mac.
The Fed’s goal is to ensure the money market mutual fund industry (worth some $3.8 trillion) will continue to function if investors make substantial withdrawals. The facility introduced this week will allow the Fed to make 1-year loans to institutions with top quality assets, such as U.S. Treasury bonds.
The Fed is using the measure to encourage U.S. banks to buy mutual fund assets, which reduces the risk those funds face if they were forced to sell their assets at a discount in the event of, e.g., a period of substantial rapid withdrawals. Such Money Market Mutual Funds are designed to be low-risk options for households and businesses to hold cash, and they limit their investments to high-quality assets such as government bonds and commercial paper.
“The Fed sits at the top of the global money/credit hierarchy—with unlimited balance sheet,” wrote Nick Reece. “And consistent with its original reason for being, will continue to be the (global) lender of last resort.”
Reece said he expects “a significant increase in the Fed’s balance sheet in the weeks and months ahead with QE, commercial paper, foreign swap lines, and usage of the discount window. Also, we may see increased coordination between the Fed, Treasury, and Congress as policy makers work to minimize the economic damage of this exogenous shock. I expect that policy makers will act aggressively.”
