Earlier this week, the Fed unveiled a temporary repo facility with foreign central banks and international monetary authorities aimed at averting the kind of Treasury liquidations witnessed in March, when market participants sold anything that wasn’t tied down in order to raise USD cash.
The new facility is necessary, the Fed explained, to ensure “the smooth functioning” of markets “including” the UST market, traditionally the deepest, most liquid market on the planet, but a space where things went horribly awry midway through last month.
“The facility reduces the need for central banks to sell their Treasury securities outright and into illiquid markets, which will help to avoid disruptions to the Treasury market and upward pressure on yields”, the statement went on to say.
Long story short, foreign central banks can post their Treasurys for dollars, which can then be made available to entities in other locales.
“This facility should [provide] an alternative temporary source of US dollars other than sales of securities in the open market”, the Fed said. The visuals below depict the sharp deterioration in market depth.
Note that the facility is aimed at killing two birds with one stone. In addition to discouraging indiscriminate selling of Treasurys into a thin market (thus exacerbating an already chaotic situation), this is designed to serve as an additional source of dollar liquidity and thereby compliment the swap lines which were enhanced as part of the raft of measures rolled out on March 15 and then expanded on March 19.
Well, as it turns out, foreign central banks liquidated the most Treasurys on record in March, underscoring why the Fed felt the need to take additional action.
Specifically, the latest update to the H.4.1 data shows that marketable US Treasury securities held in custody for foreign official and international accounts dropped by $109.011 billion last month. That’s a record – and it’s not even close.
Although the Fed’s swap lines were extended last month to include Australia, Brazil, Denmark, Korea, Mexico, New Zealand, Norway, Singapore and Sweden (in addition to the standing arrangements with the BOC, the BOE, the BOJ, the ECB and the SNB), that’s just 14 central banks.
Apparently, oil exporting countries and smaller Asian economies were liquidating Treasurys in March, while central banks more generally were dumping their least liquid US debt, exacerbating last month’s dramatics (see here).
Remember, there are pegs that need to be maintained, and during times of acute stress accompanied by dollar strength, interventions aimed at stabilizing local currencies are sometimes necessary. Throw in the USD funding needs of corporates in foreign locales, and the swap lines either weren’t adequate, weren’t enlarged enough (i.e., the Fed didn’t cast a wide enough net) or some combination of both.
So, if you were wondering why the Fed introduced yet another emergency facility this week, or if you were just curious to know who was selling Treasurys to raise USD cash and by how much, now you have some idea.
I’ll leave you with a passage from Zoltan Pozsar’s March 3 note (discussed here) which now seems even more prescient:
In the case that banks in China are overwhelmed with a drawdown of dollar deposits, their natural port of call will be the PBoC for dollar liquidity. In turn, the PBoC’s port of call will be dealers first in Hong Kong and London and then the primary dealers in New York. The PBoC — like all major central banks — keeps a portion of the liquidity tranche of its FX reserves in FX swaps, where they lend U.S. dollars in exchange for euros and yen. But if they need to start lending dollars to local banks through bilateral arrangements, China effectively flip-flops from being a lender of dollars to being a borrower of dollars in the FX swap market, and dealers in Hong Kong and London now have to find the missing link to their previously matched $/¥ and €/$ FX swap books. As the PBoC goes from funding carry traders in the FX swap market to helping local banks bridge dollar deficits, it naturally transmits local imbalances globally and carry traders end up holding the bag… …the Fed’s dollar swap lines could be called by FX swap dealers in London. Once the PBoC exhausts its dollar liquidity in cash markets like the FX swap market, it will next tap its Treasury portfolio and will either repo or sell those Treasuries through dealers in New York to raise more dollars to lend to local banks. The one place the PBoC won’t go to raise dollars is the Fed’s dollar swap lines — because it has no line to the Fed!