FIMA repo facility to the rescue - Solving the dollar liquidity crisis

There is a dollar shortage, or more critically, a dollar liquidity shortage. The disconnect in covered interest rate parity, (cross currency basis), signals that there is a shortage of dollar capital to meet the demand for dollars. The cross-currency basis widens or becomes more negative when there is large dollar demand. A negative basis means that a dollar borrower will receive less on his non-USD portion of the swap. This numbers were significantly negative in mid-March. This March pressure has been partially relieved because of Fed dollar swap lines, the swapper of last resort, and normalization of short-term lending. Unfortunately, some of this improvement is associated relative money market rates and not just a reduction in dollar pressure. 

In spite of all the increases in the Fed balance sheet and the cut in rates, the dollar has still gained because the size of the dollar liabilities that need to be hedged are large, dollar trade cash flows have fallen, and large outflows in foreign assets have looking for dollar safety. Some of this dollar pressure has fallen in the last week, but short-term global lending markets are far from normal. 

The Fed added swap lines like 2008 for major central banks, but the dollar liquidity problem is not just for a few of the large central banks but more broad-based. Many central banks have been selling Treasuries to meet some of this local dollar demand. Their large Treasury balance were grown just for this type of problem, a sudden stop in trade flows that reduce dollar cash flows. Nevertheless, what EM foreign central banks really need is access to dollar funding that does not drawdown their assets which sends signals of currency strain. 

A repo line that allows the central banks to use their Treasury holdings held in custody at the New York Fed could provide what is needed in a manner that provides global liquidity while the Fed gains collateral for providing their lender of last resort function. Thus, the Fed announced the FIMA (Foreign and International Monetary Authority) Repo Facility last week.

The Fed is now playing an even greater role as a global central bank and not just the central bank for the US. There is no international organization that can provide the necessary liquidity. Right now, what is good for global central banks is also good for the US, but this adds another layer of monetary complexity along with QE4, and domestic lending programs. The Fed balance sheet is not a US balance sheet, but an international monetary balance sheet.