It would be hard to suggest the Fed didn’t get the message.
Less than 12 hours after announcing a money market liquidity facility aimed at ensuring runs on prime funds don’t end up effectively blunting the positive impact of the commercial paper funding vehicle reinstated earlier this week, the Fed took action again to alleviate a global squeeze in dollar funding.
On Thursday morning, the Fed announced new swap lines with New Zealand, Australia, Brazil, South Korea, Denmark, Norway, Singapore, Sweden and Mexico.
“These facilities, like those already established between the Federal Reserve and other central banks, are designed to help lessen strains in global US dollar funding markets, thereby mitigating the effects of these strains on the supply of credit to households and businesses, both domestically and abroad”, the Fed said, in a statement.
Over the past several days, FX markets have become virtually untradeable. The dollar-funding squeeze manifested in cross-currency basis was feeding into spot markets, pushing the greenback inexorably higher against almost everything, creating chaos.
“FX remains untradeable. Cross-currency basis is stretched again, and more stretched outside the currencies where there are swap agreements with the Fed”, SocGen’s Kit Juckes wrote Thursday morning, adding that while he “rarely looks at Kiwi basis, it’s dramatic [and] there’s a clear link between this kind of stress and a stronger dollar”.
On Wednesday, the pound plunged some 5% to the weakest since 1985, while NOK, MXN and RUB have all been crushed.
ING’s Chris Turner called it “armageddon”. “Despite some large-scale measures to address dislocation in USD funding markets, the dollar advance has not slowed”, he wrote Wednesday, amid the tumult. “Instead, it has accelerated in a disorderly fashion”, he went on to warn, noting that “4%-7% moves in the dollar against the likes of GBP and NOK are extremely rare [and] one-week implied volatility in the $/G9 pairs are in the 15-25% range, $/NOK at 40% — a new all-time high”.
Although the Fed enhanced its swap lines with the G-7 as part of the raft of measures announced on Sunday, short-end and FX strategists immediately called for the USD liquidity arrangements to be expanded.
“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”, Zoltan Pozsar wrote Monday. “The dollar funding needs of both banks and non-banks is what’s at risk and the assets that are being funded are US assets — Treasuries, MBS and credit — so the Fed has a vested interest”.
“Cross-currency basis is the most direct measure of the ‘true’ cost of borrowing dollars in the FX market and remains extremely volatile”, Deutsche Bank’s George Saravelos wrote in a Thursday note. “It has not returned back to normal levels despite the auctions earlier this week”.
The new facilities will be in place for “at least six months”, the Fed said Thursday.
For Australia, Brazil, Korea, Mexico, Singapore and Sweden, the new facilities will provide dollar liquidity of up $60 billion. For New Zealand, Denmark and Norway, the amount is $30 billion.
This, combined with Wednesday evening’s money market facility, should go a long way towards pacifying critics and satisfying the market that the Fed is acutely aware of the avenues through which stress is proliferating.
To be clear, this is a big deal. “The global shortage of dollars is probably the issue confronting markets at the moment, and these moves should help ameliorate the squeeze…eventually”, Bloomberg’s Cameron Crise wrote.
“There are two side to this: Firstly, oil-sensitive currencies are hit by the collapse in crude prices”, SocGen’s Juckes said, prior to the rolling out of the new lines. “As for the rest, the scramble for dollars and the lack of liquidity have resulted in developed currencies trading just like emerging market ones”, he added. “As long as markets are stressed the dollar is bid”.
Thursday’s move is certainly a welcome development, but it’s far from clear that things will be back to “normal” anytime soon.
“The 2007-08 crisis showed that it took at least a couple of weeks for funding conditions to stabilize before the FX market returned to its traditional macro drivers”, Deutsche’s Saravelos remarked. “We worry this time it may take even longer, not least because of the imminent lock-downs on New York and London trading floors will make liquidity conditions even worse”.