Why The Dollar Poses A Global Headache 1: FIMA
As the Dollar enters the new year still trading strongly against a broad basket of currencies, it is a good time to gain a deeper understanding of the headache it poses for the rest of the world.
After all, a stronger USD points towards higher demand for the currency, which opens up the possibility of the next global Dollar crisis.
Let’s begin with a bit of recent history.
During the previous crisis in 1Q 2020, the Fed expanded the availability of its emergency Dollar swap lines with other central banks to help ensure that the global economy could get enough USDs to function.
Then, in 2021, they established the Foreign and International Monetary Authorities Repo Facility (FIMA), which is simply the standing (permanent) version of the emergency swap lines, ostensibly to aid in the next crisis.
While FIMA has yet to be tested, we can get a sense of its potential efficacy from how its predecessor was used.
As the chart above illustrates, use of the swap lines by foreign central banks has been heaviest during times of global crisis, when markets all over the world are in free fall and Dollar funding dries up. Which is one of the reasons why the Fed has moved to make FIMA a standing facility rather than an ad hoc one.
More importantly, the chart also shows that Fed Dollar liquidity is not normally needed, but when it is needed, demand for it comes all at once, and in significant amounts.
This presents the largest problem facing both FIMA and the SRF – that their daily limits might be overwhelmed. In the case of FIMA this amounts to $60 billion per counterparty.
Unfortunately, use of the Fed’s swap lines during the height of 2020’s financial crisis does not directly translate into future use of FIMA because of differences in tenor.
Over the 4 month period from March to July 2020 year, when global central banks were tapping the Fed’ swap lines the most, the shortest tenor repo was for 7 days, not overnight. As such we can’t really look at what happened in 2020 for direct indications of future take up of FIMA.
That being said, 2020’s figures will still give us some idea of what to expect in the next crisis.
Over the period of March to July 2020, the Bank of Japan’s largest transaction with the Fed was $74 billion for 84 day repo, and $35 billion for 7 day repo. The ECB’s largest transaction with the Fed was for $76 billion for 84 day repo, and $36 billion for 7 day repo.
If global central banks, in a future crisis, face maximum daily USD liquidity needs of the highest amounts repo-ed on a 7 day basis in 2020, that is ~$35 billion, then FIMA’s $60 billion limit will be fine.
However, do note that both the ECB’s largest repo transactions were entered into on the same day; and Japan’s largest transactions were entered into on consecutive days.
It is days like these which are of the greatest concern, and will test FIMA’s efficacy in meeting its objectives of keeping Dollars flowing to the foreign central banks lucky enough to have access to it. (Bear in mind that the Fed can always increase the $60 billion limit if it wants to)
On a different note, it is a big positive that the Fed has, with the establishment of FIMA, finally formally recognized the global scope of the USD.
It must be pointed out that this is not a concept that is alien to them, as the Fed has had to deploy emergency USD swap lines in response to various crises over the past few decades, with 2008 and 2020 being the most notable examples.
Making the swap lines a permanent repo facility simply acknowledges that the global economy is dependent on access to Dollars.
However, just as it is with the SRF, FIMA does not actually solve the underlying problem of why USDs become scarce during times of crisis.
In this case, it is risk aversion on the part of international Dollar lenders, exacerbated by widespread collateral hoarding, which causes the shortage.
To be continued…
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