The Federal Reserve’s efforts to provide liquidity to US financial markets, as well as international financial markets, seems to have been quite a success… so far.
Banking systems and financial markets around the world seem to be quite stable as economies try to recover from the recession caused by the spread of the coronavirus pandemic.
In the international sphere, we have Martin Arnold and Eva Szalay in the Financial Times writing about how the overseas lending of the Federal Reserve has served its purpose and is now receding.
Central bank swaps totaled only $45 million on the Fed’s balance sheet on March 18, 2020. Note that total is just in the millions.
On March 25, the amount of central bank swaps totaled $206.1 billion. Yes, that’s right, the figure is in the billions!
On May 27, central bank swaps reached their peak of $448.9 billion, and then began to decline.
At the close of the latest banking week, August 19, central banks swaps dropped below $100.0 billion closing out at $95.8 billion.
Four central banks accounted for most of the swaps, the European Central Bank, the Bank of England, the Bank of Japan and the Swiss National Bank.
Originally these central banks offered auctions of dollars on a daily basis. Then in June, the number of auctions was cut back to three days a week. Last Thursday, the number of auctions was cut back to one per week.
In March, the demand for US dollars was quite high. On March 20, it took just $1.0667 to purchase one Euro. The US dollar index (DXY) was at 102.71 on that same day.
Signs of the success of the operation could be seen in June as the demand for the US dollar dropped off. Around the middle of the month, $1.1200 could buy one Euro and the US dollar index had risen to somewhere around 97.00.
On Friday, August 21, one Euro cost around $1.1800, although in the past week, the cost was around $1.1900 percent. This represents a decline of a little more than 10.0 percent.
The US dollar index was a little below 93.00, also representing a 10.00 percent decline.
There is more at work on the decline in the value of the dollar, but the success of the central bank swap program has certainly helped to reduce the demand for dollars in world markets.
Mr. Arnold and Ms. Szalay quote Kamakshya Trivedi, a currency strategist at Goldman Sachs in London, as remarking:
“…the cost of accessing short-term dollar funding had normalized in both emerging and developed economies, making it likely that the use of the facility would be tapered further in the coming months.”
Federal Reserve Balance Sheet Changes
Since May 27, the Federal Reserve balance sheet has changed. As we have just been discussing, central bank swaps have been reduced with the decline totaling $353.1 billion. In addition, the Fed’s acquisition of Repurchase Agreements has fallen to zero, a reduction of $181.1 billion. The two combined represent a decline in assets of $534.1 billion.
Offsetting this decline, the Fed added just about $400.0 billion securities held outright. Overall, the assets of the Fed dropped by just under $90.0 billion.
But, the reserve balances with Federal Reserve banks, a proxy for the excess reserves of the banking system, dropped by almost $500.0 billion. So, there were other drains to the commercial banking system that resulted in this decline.
The public’s demand for coin and currency continues to rise. Since May 27, $61.5 billion in cash has left the commercial banking system. In addition, the federal government continues to remove money from the banking system. Since May 27, almost $380.0 billion has been transferred from government holdings in the banking system to the Federal Reserve.
Adding together the $380.0 billion and $61.5 billion along with the $90.0 billion, we account for $531.5 to offset the $534.1 billion of asset declines coming from the decline in swaps and the decline in repurchase agreements. Here you have the major changes taking place on the Fed’s balance sheet from May 27, 2020 to August 19, 2020.
Plenty Of Liquidity In Banking System
There is still plenty of liquidity in the commercial banking system. Reserve balances with Federal Reserve Banks (excess reserves) still totals $2,821.8 billion. This is down from a peak of $3,317.7 billion on May 27. (Note that this last date is when the central bank swaps account also peaked.)
Investors should feel comfortable that the Fed continues to support the liquidity needs of the financial markets in the United States.
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