Research Summary
This report discusses the global dollar endgame, focusing on the Federal Reserve’s stealth easing programs, the acceleration of dollar strength, and the expansion of the U.S. central bank’s global swap network. It also delves into the financial stability of the Fed’s post-crisis system, the “repocalypse” of 2019, and the role of the FX swap market during financial crises.
Key Takeaways
The Federal Reserve’s Stealth Easing Programs
- Stealth easing programs persist: Despite the continuation of the Federal Reserve’s stealth easing programs, dollar strength has begun to accelerate once again.
- Global swap network expansion: As liquidity drains, the world’s response will not be to de-dollarize but to seek more dollar liquidity, leading to the expansion of the U.S. central bank’s global swap network.
- Excess collateral era: Prior to the Fed’s liquidity injection to stem COVID fears, global markets had entered a lengthy “excess collateral” era, with almost every dollar being deployed by private sector entities into trades that did not alter the Fed’s balance sheet.
The “Repocalypse” of 2019
- Funding squeeze: In September 2019, a funding squeeze caused money market rates to skyrocket, leading to a frantic search for other sources of dollar funding.
- Fed’s response: The Fed responded with a Standing Repo Facility, which helped to subside the “repocalypse”.
- System instability: The event revealed that the financial system was not as stable as assumed by monetary leaders and prominent financial players.
The Role of the FX Swap Market
- FX swap market stress: During the “repocalypse”, the $4 trillion-a-day FX swap market underwent mild stress, which was barely covered in the media.
- Rate spike: As smaller participants failed to locate funding in repo and interbank markets, the rate to borrow dollars secured against foreign currencies spiked.
- Fed’s global dollar swap network: The world acknowledged the Fed’s global dollar swap network as the sole rescue mechanism for the FX swap market in times of crisis.
Actionable Insights
- Monitor the Federal Reserve’s actions: The Federal Reserve’s actions, such as the continuation of stealth easing programs and the expansion of the global swap network, can have significant impacts on dollar strength and liquidity.
- Understand the implications of the “repocalypse”: The “repocalypse” of 2019 revealed the instability of the financial system, which can have long-term effects on global markets.
- Consider the role of the FX swap market: The FX swap market can undergo stress during financial crises, and the Fed’s global dollar swap network can serve as a rescue mechanism. Understanding these dynamics can provide valuable insights into the global financial system.
