By George Saravelos, global head of FX Research at Deutsche Bank
As the market awaits the FOMC meeting, it is important to highlight a development in dollar liquidity that will take place irrespective of the Fed in coming weeks: the literal injection of around a trillion Fed-printed dollars into the US economy, a textbook helicopter drop of money (first discussed in "Head of FX Research"Mind-Boggling Liquidity": Nobody Is Paying Attention To The $1.1 Trillion Flood About To Hit Markets").
The mechanics of this injection are simple: the US treasury issued "too much" bonds at the peak of the crisis last year, which the Federal Reserve bought up via extreme amounts of QE. This extra cash was then placed on deposit at the Fed by the US Treasury, ring-fenced from the financial system and the economy. It is now being deployed into the market via the mailing out of paychecks as well as the other components of the Biden stimulus signed into law last week.
Some of it will be spent, some of it used to buy equities and other kept in cash. But from a financial market perspective what is important to highlight is that this is a near-literal helicopter drop of dollars worth about a trillion.
Dollar implications run two ways.
- On the positive side, further liquidity injections and heightened inflation fears will lead the market to continue to question the Fed's commitment to not hike rates under its new regime.
- On the negative side, such helicopter drops are textbook currency debasements, in addition to the near-term downside impact they are having on very front-end yields.
We have taken a much more neutral stance on the dollar in Q1 of this year reflecting the competing tensions between these two narratives but ultimately lean in the dollar negative direction.
Either way, the policy experiment is about to accelerate.