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In the clearest hint yet that last month’s financial market volatility is mostly over, the world’s top central banks have decided to reduce the frequency of their dollar liquidity operations with the U.S. Federal Reserve beginning in May.
After consulting with the Federal Reserve, the Bank of England, the Bank of Japan, the European Central Bank, and the Swiss National Bank have chosen to return to weekly U.S. dollar repo operations. This decision indicates that the emergency safety net is no longer required, as financial stress has subsided.
“The Bank of England continues to stand ready, alongside other central banks, to re-adjust the provision of US dollar liquidity as market conditions warrant,” the central bank said in a statement on Tuesday.
Only a month ago, the Federal Reserve offered daily currency swaps to ensure banks in Canada, the United Kingdom, Japan, Switzerland, and the eurozone had the dollars they needed to operate, replicating steps taken to mitigate the impact of the COVID-19 pandemic in 2020 and the Great Financial Crisis in 2008-2009.
This action was taken in response to the potential for an immediate and widespread loss of trust in the soundness of the financial system following the failures of Silicon Valley Bank and Credit Suisse.
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What Exactly Are Central Bank Swap Lines? Swap lines are liquidity backstops that avoid global financing market disruptions and have been part of top central banks’ collaboration for over a decade. Swap lines with the Federal Reserve allow foreign central banks to obtain U.S. dollars from the Fed in exchange for a similar amount of foreign currency provided to the Fed.
What Effect May This Have On The Market? Over the past month, daily dollar swap lines have supplied much-needed liquidity to ease pressures on the financial system and prevent localized bank failures from snowballing into a worldwide credit crunch. Now that the emergency is over, central banks can resume their normal weekly liquidity operations. While this reassures investors that the banking system is finally out of the woods, it also means that markets will need to readjust to the return of normal liquidity levels.
FX Market Reactions: Dollar Strengthened
The U.S. Dollar index (DXY), which is tracked by the Invesco DB USD Index Bullish Fund ETF UUP moved higher on Tuesday, up 0.2% on the day. The euro and the pound both weakened, by 0.2% and 0.4% respectively.
The yen and the Swiss franc held steady against the USD, supported mostly by a rising sentiment of risk aversion in equity markets.
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