Are The Fed's Rapidly Disappearaning Central Bank Liquidity Swaps Crushing The Dollar?

Tyler Durden's picture

As frequent readers know, Zero Hedge compiles an update of the Fed's balance sheet every week, based on the most recent H.3 and H.4.1 statements. One odd trend that has caught our attention is the virtual disappearance of central bank liquidity swaps as disclosed in the weekly H.4.1 report. The historical low level for this metric was in the pre-Lehman days when it averaged about $60 billion weekly. Then in the depth of the crisis it peaked at just under $600 billion in December 2008. Yet, oddly, even though Europe's economic and monetary situation has deteriorated since then, the foreign CB swaps have plunged, and are now almost at pre-Lehman levels: the most recent reading was of $100 billion, a half a trillion decline from the peak! Two main questions arise:

1. Is this swap contraction premediated, and is the Fed essentially forcing foreign Central Banks to sell dollars into the open market, thus driving the dollar persistently lower. A comparison of the DXY with the total outstanding in CB swaps indicates that there, if nothing else, a strong correlation between the two.

2. What will happen with the foreign Central Banks end up needing the US' swap backstop again? Even if the dollar devaluation is not an ulterior motive but merely a side-effect of this balance sheet contraction, the next time half a trillion in CB swaps is pumped into the system, one can only imagine the consequences for the dollar. If half a trillion taken out is what it took to majorly whack the dollar (and to make commodities and stocks more attractive to foreigners), then the inverse should have a diametrically opposite effect. Of course, the Fed is pricing to perfection as usual, and keeping its fingers crossed it will never need to loosen up its CB swap lines again. That always works as a strategy, until it doesn't. And if recent feedback from Europe is any indication, the next strategy for Bernanke is the old ostrich head in the sand routine.

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Anonymous's picture

Crushing the dollar is bullish for stocks and commodities.

EQ's picture

"Crushing the dollar is bullish for stocks and commodities."  Wrong!


The Fed will not be able to provide the necessary swap lines demanded by the global economy ad infinitum.  And how is that bearish for the dollar?  To the contrary, it is bullish.   Get ready for the great race.  The race to acquire dollars. 

Anonymous's picture

I'm sure you shorted 875. This business is not about having an economic degree, it's about making money trading.

slasher's picture

The Fed will not be able to provide the necessary swap lines demanded by the global economy ad infinitum.  And how is that bearish for the dollar?  To the contrary, it is bullish.   Get ready for the great race.  The race to acquire dollars. ...agree that,s why our economy is screwed up good articles

Anonymous's picture

I think it works the other way: The Fed is unwinding the swaps as the dollar naturally weakens, as a way of trying to support it.

The swaps were opened up when demand for dollars was tight and both the Yen and Dollar were soaring against everything else. The swaps provided foreign banks with a big supply of dollars they could lend out so speculators and businesses wouldn't have to buy so many on the open market.

Now the dollar is weak because the US economy is going down the tubes. I think the Fed has been trying to prop up the dollar by letting the swaps expire and push everyone back to the market for the dollars they need.

lewie's picture

that's my take as well...the need for dollar funding worldwide is most likely abating sooner than expected...

when funding is oversupplied, the dollar can only weaken...especially when dollar-based assets are becoming more and more dubious


Anonymous's picture

It's not that the Fed is unwinding any swaps, it's that we have seen some calm in the market as the Fed opened substantial swap agreements with central banks around the globe. ie Jamming an enormous mansandwich of liquidity into global central banks. Basically, the credit trade has stablized and there is no need to extend any new swap agreements. This is common sense. You see the symptomatic effects in the credit spreads tightening across the board and the happy horseshit the bull-oney crowd is pumping. The Fed didn't unwinding anything. But, this ongoing swap trade cannot sustain itself. The Fed's swap agreements are no different than any other "derivative" or financial contract that, at their core, are a mad house. In other words, the liquidity and counterparty risks Tyler has talked about ad infinitum are essentially reflective of the weapons of mass destruction we now call central bank swap agreements. I have some idea what is going on because I foretold of the end of the world and Frankenstein finance on my blog and I watch the Fed like a hawk.

So......if you folow this through to an ultimate outcome, nothing good can come of this. Many foreign central banks likely will reach a point that they cannot fulfill their swap agreements. Party over. Additionally, at some point many nations that don't have swap agreements with the U.S. will likely seek their own lines. Many or most of those countries will ultimately become major counterparty risks to the United States in any such agreement. Likely so much so that the Fed will not be accomodative because of this risk or if they wish to be accomodative because Bernanke believes the U.S. is responsible for doing so as the world's reserve currency, our government could stop them for overreaching. If they do overreach and no one stops it, we will likely see the American people holding the bag in swap agreements with the buffoons in China, Russia or even wealth countries that have doled out their dollars to Eastern Europe as an example. Then what happens? We have World War IV or the U.S. tells people to go fuck themselves or some equally pleasant Cracker Jack prize.

Life's a bitch and then you die. Or, I think there is some remark on here about zero hedging? Well, that's where we are right now with globalization. Your only hedge into the globalization story is to stick your head up your ass and say goodbye.

The dollar is not going to tank. Wake up people. Christ I'm sick of this mumbling bullshit.

EQ's picture

Oops, I didn't sign in when posting that.  

Anonymous's picture

Then this rally is the last hurrah before a breakdown in the fall. But I also think we will manage the year up, once the dust settles. Next year could be the real trap. I'm patiently waiting to short EUR/USD at 1.45 this summer.

finan_learn's picture

Could someone explain both sides of the argument in layman's terms? Could you please explain if these swaps were created historically - prior to this crisis?

jm's picture

The dollar swaps are lines that provide foreign central banks with dollars, presumably to bail out their own failing banks.  In the same way, there are FX lines designed to provide the Federal Reserve with the capacity to offer liquidity to U.S. institutions in foreign currency.    Everything done by pre-standing arrangement only among good friends.

EQ thinks bullish because there is a breaking point that leads to a currency collapse.  Before that, he thinks the swaps will get pulled, as a wrecked currency is the worst possible outcome.  Since much of the world's bonds are dollar denominated (reserve curency) the pull will lead to a debt-deflation.  $ goes way up.


Others (?) think that pulling the swaps 1) cause other central banks to liquidate $ assets to inject cash in their financial systems, and 2) assume that we are nowhere near a currency crisis, and as a non-concern, the Fed will just start the swap lines up again as needed.  More supply crushes the dollar.

Either way, the outcome for a county with trillions in government liabilities AND a reserve currency is unknown.  We're in Extemistan now. 

EQ's picture

"Others"??.....Not at all.  I clearly believe in the scenario I outlined there is only one eventuality for these other countries.  Their central banks will be forced to liquidate dollar assets and I have written of this fact for years. But, they will be forced to do so.  And, in that outcome, it won't be because the dollar is collapsing or that we will have a dollar crisis.  It's because those countries will have their own currency crises and will need those dollars to fund their own economies.   You don't have to fantasize what I have written in the remarks under this post.  It is happening as I type this.  Just look at Russia or Brazil today.  The world is unfolding exactly as I have typed it.    The dollar is surely not going to collapse because China has to liquidate $1.8 trillion in dollar holdings.  That is most preposterous.   Dollar bears are dolts.  


Enjoy the ride.   

finan_learn's picture

Thanks for the explanation.

Here is what I understood earlier: US Fed established swap credit lines with other countries (say Country A and its currency is Euro) so that Banks in A could borrow $s from A's central bank to be able to meet their liquidity/repayment needs for $ denominated liabilities. This was done since they were unable to roll over(/raise/buy $) their $ deonominated foreign currency debt. If 10 countries such as A were to draw from the swaps, the $ supply would go way up and would crush the $ even though US would end up carrying 10 other foreign currencies.

Could someone validate this statement: When other central banks draw$ from the lines(swap), since it is a fiat currency system, they need to really remove the approprite local currency from thier system.

May be we are reading too much into this reduction in credit lines. May be it is a sign that the conditions that were causing the inabilities to raise/rollover $ denominated debt have been abated and they are not required any more due to improvement.

I didnt read the report but have any of these countries used the swap? Would that give us a good indication of whether it i has in fact caused debt deflation(whch I am to understand is reduction in supply/demand for debt).

Anonymous's picture

OUCH-somebody is dumping the DXY today and look at the "Intel rally." The media won't talk much about the bear raid on the dollar and how a bad dollar(ie: state sanctioned stealing) helps commodities and stocks...even microscopic amounts.
So, this SWAP article implies the Fed no longer thinks we need SWAPS to bail out non-dollar countries in the fall? Or are they deravelling knowing that it's pointless to save them in the Fall?

TheDreadPirateRoberts's picture

The liquidity swaps and the declining USD have a common causal factor but the change in swaps is not causing the change in the USD. The US is bankrupt. US paper is everywhere. When the catalyst occurred, a scramble to meet margin calls on declining USD assets (like MBS) ensued. Actual dollars were scarce. Credit had created the impression there were more dollars than there were. Once credit vanished dollars were scarce relative to the demand for dollars to pay margin calls. To prevent the collapse of foreign banking systems, which would have blown up what's left of our system too, the Fed distributed dollars through foreign central banks via these swaps. Now that the margin crunch has subsided, the Fed can reduce the swaps. Until the next crisis.