Global dollar crunch appears over as central banks rely less on Fed backstop

By Dan Burns and Megan Davies
(Reuters) - A global dollar crisis that marked the early moments of the coronavirus crisis appears to be over. This is the latest milestone in a remarkable turnaround in financial terms developed by the Federal Reserve and other leading central banks.
Fed data on Thursday showed that its benchmark banks had tapped worldwide for the fewest dollars in nearly three months this week, and this was the main factor behind a surprising reduction in the Fed's $ 7 trillion balance sheet - the first since February and the biggest since the waning days of the financial crisis more than a decade ago.
(GRAPHICS: The Fed's balance sheet shrinks at https://fingfx.thomsonreuters.com/gfx/mkt/oakpeqdwmpr/Pasted%20image%201592513591207.png)
The Fed's foreign currency swaps with other central banks decreased Wednesday's $ 92 billion from $ 444.5 billion the previous week to $ 352.5 billion. The total amount outstanding on the swap lines, intended to alleviate the rising demand for US currencies in the jurisdictions of participating banks in the first weeks of the crisis, was the lowest since early April.
Along with other signs of a declining demand for a variety of Fed emergency liquidity facilities, the reduction in the use of currency swap lines is, for many analysts, a sign that global financial markets are nearing normal after the Corona virus outbreak in February and March.
During this period, stocks plunged into the bear markets at record speed, risk premiums on the credit markets skyrocketed, and demand for greenbacks overseas exceeded supply significantly, making the dollar unbearably expensive for foreign governments and companies with dollar-denominated debt. The Fed quickly attempted to restore order and, together with the US-market facilities, expanded the FX swap line arrangements to nine central banks in addition to the five with which it had permanent arrangements.
"Given the restored health of the (dollar) financing markets and the fact that the swap lines continue to act as a setback, we expect this transfer from central bank liquidity to the market to be relatively uneventful," said John Roberts, a US rate strategy analyst at NatWest Markets.
But delivering from here can be quick.
"We expect a faster decline in the coming months as the majority of swaps will roll off," Citigroup economists wrote in a message to customers on Friday.
(GRAPHICS: The dollar crisis is over https://fingfx.thomsonreuters.com/gfx/mkt/gjnpwwgkdpw/Pasted%20image%201592588617801.png)
In addition to the decline in swap line usage, some Fed emergency facilities have seen declining demand in recent weeks. Outstanding balances in programs offering loans to primary traders, commercial paper issuers, money market funds and direct bank loans to meet reserve requirements have been on a plateau or have fallen sharply since May.
Perhaps the most emblematic example of the turnaround is the decline in demand for repurchase agreements - or repos. The outstanding amounts for these short-term financing transactions between commercial banks and the Fed are at their lowest since September last year, when the central bank was forced to pump billions of dollars into the market due to a liquidity squeeze.
The repo squeeze exploded again in mid-March when state issued state-at-home orders and mass closings of nonessential companies to control the spread of COVID-19.
On March 18, the Fed posted a record repo balance of nearly $ 442 billion. Last week, after a week-long decline from $ 88 billion to $ 79 billion, the value had dropped. It was the lowest since mid-September when the Fed was first forced to intervene in this market.
Zoltan Pozsar, managing director, investment strategy and research at Credit Suisse, said in a research note last week that the Fed will do this if foreign banks "take the US dollars they have taken off the swap lines and lend to them." Stop FX swap market, no longer need. " Be there to get into the repo facility. "
(GRAPHICS: Repo demand weakest since September https://fingfx.thomsonreuters.com/gfx/mkt/qmyvmgmxqvr/Pasted%20image%201592579378496.png)
Declining demand has risen as the markets regained their feet after the large swoon in March. Equities have recovered around 90% of their losses, companies are raising capital on the bond market at record speed, and risk premiums embedded in corporate bond yields are back at the level of early March.
Financing costs in US dollars have also largely normalized. For investors in Japan and Europe, whose central banks have been the largest users of the Fed's swap lines since March, the cost of accessing greenbacks to finance transactions is back to the level at the end of February.
One possible benefit in reducing US dollar funding pressures is that US assets such as government bonds will become more attractive, which will support demand for US government bonds given a record $ 3 trillion in borrowing to fund pandemic relief efforts could.
"The cheapening of USD funding has made it more attractive for foreign investors to buy long-term US government bonds," said Roberts from NatWest. "We see this as a measure that would support foreign demand for US government bonds."
(Reporting by Dan Burns and Megan Davies; editing by Leslie Adler)
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