Fed Currency-Swap Lines – Liquidity for the World

In a press release on September 18, the Federal Open Market Committee announced a $180 billion expansion of the swap lines with foreign central banks, including Bank of Canada, the Bank of England, the European Central Bank (ECB), the Federal Reserve, the Bank of Japan, and the Swiss National Bank. The line has resulted in a decline in the inter-bank overnight lending rate amidst uncertainty of the assets in the counter-party bank. The Federal Reserve Bank of Atlanta provides detail on the swap mechanics.

What does this mean for the US Dollar? Empirically it may be difficult to disaggregate the increased liquidity for US Dollars in foreign markets and the impact on exchange rates from the other, more newsworthy, actions by the US Treasury. European markets saw a substantial decline in the overnight LIBOR (3.843% vs. 5.031%). In this case, many financial institutions did not have access to US Dollar overnight lending and the ECB first auction resulted in substantial demand ($101 billion for the $40 billion offer). The demand was not as strong at the BofE or the Swiss Bank as the central banks have varying collateral standards. Injection liquidity into the market is often an inflationary move, but in this instance it may prove to counterbalance a deflationary Wall Street characterized by tight lending practices, shrinking balance sheets, and cash hording.

Roughly twelve months ago, Former Governor Frederic S. Mishkin noted in his speech, “Systemic Risk and the International Lender of Last Resort”, that the lender of last resort was to provide the following: “(1) restore confidence in the financial system by quickly providing liquidity, (2) limit moral hazard by encouraging adequate prudential supervision, and (3) act as a lender of last resort infrequently.” While the speech was focused more heavily on emerging market economies, it does point out that the injection of liquidity will come with increased regulatory scrutiny (point 2) in order to restore the confidence of market participants (point 1). We all need to hope the injections come infrequently (point 3) and Wall Street, Bay Street, and City of London return to order soon.

UPDATE: At 1:00am EDT September 24 the Fed announced an additional $30 billion of swap lines have been established with the Reserve Bank of Australia, the Danmarks Nationalbank, the Norges Bank (Norway), and the Sveriges Riksbank (Sweden). The Fed will provide up to $10B to each Australia and Sweden and up to $5B each to Denmark and Norway.