Breaking Wall Street Market News & Reports

World markets are massively short covering their positions after an announcement this morning at 8 AM EST, that the coordinated action by central banks around the world will provide more liquidity to the global financial system. The U.S. Federal Reserve, after a similar effort in September, will “lower the pricing on the existing temporary U.S. dollar liquidity swap arrangements by 50 basis points so that the new rate will be the U.S. dollar overnight index swap (OIS) rate plus 50 basis points.” Wednesday’s move from the Fed was matched by corresponding actions from the Bank of Canada, Bank of England, Bank of Japan, European Central Bank and Swiss National Bank. The new pricing applies to operations conducted as of Dec. 5, and the authorization of the swap arrangements has been extended to Feb. 13. What does this mean? Does the signal that the financial markets were really beginning to dry up with interbank lending. Was the European debt crisis beginning to unravel for the worse with the German inactions? What does mean to the Dollar? —->Devaluation 

The Dow Jones Industrial Average is up 415 points to 11,970, while the S&P 500 added 42 points to 1,237. The victim of the surge was the dollar, which stumbled on the central banks’ latest move to flood the market with more greenbacks. The euro climbed to $1.3487, from $1.3315 Tuesday. In my opinion policymakers are buying time for the Euro Zone to changes treaties and most likely drastically change the structure of the common currency (and yes, definitely kick a few members out). They also must find a way to rescue the banks and inject additional liquidity similar to the US TARP. The underlining problem remains the monstrous debt held.

While the effort to provide more liquidity may temporarily soothe the symptoms of Europe’s debt crisis and allow financial institutions easier access to funding, it does little to address the underlying roots of overburdened governments that need to be propped up while they drastically cut spending. 

The European Financial Stability Fund (EFSF) announced new leverage tools geared at increasing its lending capacity on Wednesday, but it still remains to be seen where the additional financing will come from for the public-private special purpose vehicles the EFSF intends to use to provide funding to sovereign governments through primary and secondary bond market purchases. That funding could in turn be used to recapitalize European banks that are at risk of crumbling due to their exposure to the region’s shaky credits. Those concerns took a backseat Wednesday morning though, as equities rallied and bond yields in at-risk countries like Italy and Spain held fairly steady.

China also gave the market a helping hand Wednesday, cutting the reserve requirement ratio for its banks in a bid to jumpstart an economy that has slowed from its torrid pace and fueled concerns about a hard landing that could threaten precarious global growth.

Here’s a statement from the FOMC website.

The Bank of Canada, the Bank of England, the Bank of Japan, the European Central Bank, the Federal Reserve, and the Swiss National Bank are today announcing coordinated actions to enhance their capacity to provide liquidity support to the global financial system. The purpose of these actions is to ease strains in financial markets and thereby mitigate the effects of such strains on the supply of credit to households and businesses and so help foster economic activity. 

These central banks have agreed to lower the pricing on the existing temporary U.S. dollar liquidity swap arrangements by 50 basis points so that the new rate will be the U.S. dollar overnight index swap (OIS) rate plus 50 basis points. This pricing will be applied to all operations conducted from December 5, 2011. The authorization of these swap arrangements has been extended to February 1, 2013. In addition, the Bank of England, the Bank of Japan, the European Central Bank, and the Swiss National Bank will continue to offer three-month tenders until further notice.

As a contingency measure, these central banks have also agreed to establish temporary bilateral liquidity swap arrangements so that liquidity can be provided in each jurisdiction in any of their currencies should market conditions so warrant. At present, there is no need to offer liquidity in non-domestic currencies other than the U.S. dollar, but the central banks judge it prudent to make the necessary arrangements so that liquidity support operations could be put into place quickly should the need arise. These swap lines are authorized through February 1, 2013.

Federal Reserve Actions
The Federal Open Market Committee has authorized an extension of the existing temporary U.S. dollar liquidity swap arrangements with the Bank of Canada, the Bank of England, the Bank of Japan, the European Central Bank, and the Swiss National Bank through February 1, 2013. The rate on these swap arrangements has been reduced from the U.S. dollar OIS rate plus 100 basis points to the OIS rate plus 50 basis points. In addition, as a contingency measure, the Federal Open Market Committee has agreed to establish similar temporary swap arrangements with these five central banks to provide liquidity in any of their currencies if necessary. Further details on the revised arrangements will be available shortly.

U.S. financial institutions currently do not face difficulty obtaining liquidity in short-term funding markets. However, were conditions to deteriorate, the Federal Reserve has a range of tools available to provide an effective liquidity backstop for such institutions and is prepared to use these tools as needed to support financial stability and to promote the extension of credit to U.S. households and businesses.

Bank of Canada Action

The Bank of Canada and the U.S. Federal Reserve have agreed to extend the US $30 billion swap facility (reciprocal currency arrangement) through 1 February 2013 and adjust the pricing to the U.S. dollar OIS rate plus 50 basis points. This swap facility was set to expire on 1 August 2012. The introduction of the expanded network of temporary swap lines will enable the Bank of Canada, should the need arise, to provide Canadian dollars to the other central banks, and to provide liquidity in Japanese yen, euros, U.K. pounds sterling, Swiss francs and U.S. dollars (via the existing U.S. dollar swap facility) to financial institutions in Canada. The Bank of Canada judges that it is not necessary for it to draw or offer operations on any of these swap facilities at this time, but that it is prudent to have these agreements in place. Should these facilities be drawn on, the details of the liquidity facilities provided would depend on the specific market circumstances at the time. The Bank of Canada continues to closely monitor developments in global financial markets and remains committed to providing liquidity as required to support the stability of the Canadian financial system and the functioning of financial markets.

Bank of England Action

The introduction of the network of temporary swap lines will enable the Bank of England to provide sterling to the other central banks if required, as well as enabling the Bank of England to provide liquidity, should it be needed, in Japanese yen, euro, Swiss francs and Canadian dollars (in addition to the existing operations in U.S. dollars). The Bank will continue its weekly tenders of U.S. dollar funding at fixed interest rates each Wednesday until further notice, with counterparties able to borrow unlimited amounts against eligible collateral. The rate at which tenders are conducted will be reduced to OIS+50bps (from OIS+100bps) beginning with the next weekly tender on 7 December. The three-month tender scheduled for 7 December and subsequent three-month tenders will also be conducted at OIS+50bps. In the U.S. dollar repo operations, counterparties are permitted to borrow any amount against eligible collateral.

European Central Bank Decision

The Governing Council of the European Central Bank (ECB) decided in co-operation with other central banks the establishment of a temporary network of reciprocal swap lines.  This action will enable the Eurosystem to provide euro to those central banks when required, as well as enabling the Eurosystem to provide liquidity operations, should they be needed, in Japanese yen, sterling, Swiss francs and Canadian dollars (in addition to the existing operations in US dollars). The ECB will regularly conduct US dollar liquidity-providing operations with a maturity of approximately one week and three months at the new pricing. The schedule for these operations, which will take the form of repurchase operations against eligible collateral and will be carried out as fixed-rate tender procedures with full allotment, will be published today on the ECB’s website.

In addition, the initial margin for three-month US dollar operations will be reduced from currently 20% to 12% and weekly updates of the EUR/USD exchange rate will be introduced in order to carry out margin calls. Those changes will be effective as of the operations to be conducted on 7 December 2011. Further details about the operations will be made available in the respective modified tender procedure via the ECB’s Website.

Frequently Asked Questions: Foreign Currency Liquidity Swaps

What is the purpose of the foreign currency liquidity swap lines? 

The foreign currency liquidity swap lines are designed to provide the Federal Reserve with the capacity to offer liquidity in foreign currencies to U.S. financial institutions should the Federal Reserve judge that such actions are appropriate.

Which central banks are participating in these arrangements?

The Federal Open Market Committee has authorized arrangements between the Federal Reserve and the Bank of Canada, the Bank of England, the Bank of Japan, the European Central Bank, and the Swiss National Bank. In addition, these foreign central banks are also establishing bilateral swap arrangements with one another.

Why are these swap lines being implemented?

These swap lines are being implemented as a contingency measure, so that central banks can offer liquidity in foreign currencies if market conditions warrant such actions. These lines provide the Federal Reserve with the same ability to provide foreign currency, should the need arise, as foreign central banks currently have through the existing dollar swap lines with the Federal Reserve to provide dollar liquidity in their jurisdictions.

Why is the Federal Reserve establishing lines for these five currencies and with these five central banks? 

These five currencies are used globally and account for the bulk of the foreign currency funding of U.S. financial institutions.

In what manner would foreign currency liquidity be provided?

There has not been a decision to activate the foreign currency liquidity facilities. If the Federal Reserve were to decide to offer liquidity in foreign currencies to U.S. financial institutions, the details of the operations would be determined at that time in light of the prevailing circumstances.

Will activity under the liquidity swap arrangements be disclosed to the public? 

Yes, the aggregate swap activity in each currency with foreign central banks will be published weekly. They will be found on the Federal Reserve Bank of New York’s Foreign Exchange Swap Agreement webpage . In addition, any liquidity-supplying operations in foreign currencies would be subject to the same disclosure requirements as the Federal Reserve’s dollar-based activities.

For how long are the swap arrangements expected to be in place?

These swap arrangements, along with the existing U.S. dollar swap arrangements, have been authorized through February 1, 2013.

U.S. dollar liquidity swap lines from May 2010

Why has the Federal Reserve re-established temporary U.S. dollar liquidity swap facilities with foreign central banks? 

The swap facilities announced in May 2010 respond to the re-emergence of strains in short term funding markets in Europe. They are designed to improve liquidity conditions in global money markets and to minimize the risk that strains abroad could spread to U.S. markets, by providing foreign central banks with the capacity to deliver U.S. dollar funding to institutions in their jurisdictions.

With which central banks has the Federal Reserve entered into swap facilities? 

The Federal Reserve has established swap arrangements with the Bank of Canada (BOC), the Bank of England (BOE), the European Central Bank (ECB), the Swiss National Bank (SNB), and the Bank of Japan (BOJ).

How do the swap facilities function? 

The swap lines with the ECB, BOE, SNB and BOJ provide these central banks with the capacity to conduct tenders of U.S. dollars in their local markets at fixed local rates for full allotment, similar to arrangements that had been in place previously. The swap line with the Bank of Canada allows for drawings of up to $30 billion. The terms, structure, and operational mechanics of these swap agreements closely parallel the arrangements that expired on February 1, 2010.

For how long are the swap facilities expected to be operational? 

These swap arrangements have been authorized through February 1, 2013. Central banks may request drawings on their swap lines up to the date of expiration.

Is the Federal Reserve exposed to foreign exchange or private bank risk in extending these lines? 

No. Dollars provided through the reciprocal currency swaps are provided by the Federal Reserve to foreign central banks, not to the institutions obtaining the funding in these operations. The foreign central bank receiving dollars determines the terms on which it will lend dollars onward to institutions in its jurisdiction, including how the foreign central bank will allocate dollar funds to financial institutions, which institutions are eligible to borrow, and what types of collateral they may borrow against. The terms governing these loans of dollars are in all cases released to the public by the foreign central banks. As the Federal Reserve’s contractual relationship is exclusively with the foreign central bank and not with the institutions obtaining dollar funding in these operations, the Federal Reserve does not assume the credit risk associated with lending to financial institutions based in these foreign jurisdictions. The provision of dollars and receipt of foreign currency, and the receipt of dollars and return of foreign currency at the swap’s maturity date, both occur at the same foreign exchange rate so that the Federal Reserve is not exposed to movements in foreign exchange rates.

Is activity under the liquidity swap arrangements disclosed to the public? 

Yes, swap activity is published weekly. The Federal Reserve has also released the underlying legal agreements with foreign central banks.

U.S. dollar liquidity swap lines from December 2007 to February 2010

What was the purpose of the dollar liquidity swap lines?

The dollar liquidity swap lines were designed to improve liquidity conditions in U.S. and foreign financial markets by providing foreign central banks with the capacity to deliver U.S. dollar funding to institutions in their jurisdictions during times of market stress.

What circumstances led to the implementation of these facilities?

The swap arrangements were introduced to address stresses in U.S. dollar funding in overseas markets. These difficulties were adding materially to pressures in funding and credit markets in the United States and abroad.

Who authorized the use of the swaps?

The arrangements were authorized by the Federal Open Market Committee (FOMC) of the Federal Reserve System and the policy boards or executives of the respective foreign central banks. The Federal Reserve had the right to approve or deny requests by foreign central banks to draw on their swap lines. The FOMC authorized these arrangements through February 1, 2010. The foreign central banks could request draws on their swap lines up to that date.

Which central banks could engage in swaps?

The Federal Reserve established swap arrangements with the Reserve Bank of Australia, the Banco Central do Brasil, the Bank of Canada, Danmarks Nationalbank, the Bank of England, the European Central Bank, the Bank of Japan, the Bank of Korea, the Banco de Mexico, the Reserve Bank of New Zealand, the Norges Bank, the Monetary Authority of Singapore, the Sveriges Riksbank, and the Swiss National Bank.

How were the swaps structured?

The Federal Reserve provided U.S. dollars to a foreign central bank. At the same time, the foreign central bank provided the equivalent amount of funds in its currency to the Federal Reserve, based on the market exchange rate at the time of the transaction. The parties agreed to swap back these quantities of their two currencies at a specified date in the future, which was the next day or as far ahead as three months, using the same exchange rate as in the first transaction. Because the terms of this second transaction were set in advance, fluctuations in exchange rates during the interim did not alter the eventual payments. Accordingly, these swap operations carried no exchange rate or other market risks.

How did foreign central banks distribute the U.S. dollar funding they received through these swaps?

The foreign central banks distributed the U.S. dollars they drew through a variety of methods, including variable-rate tenders, fixed-rate tenders, bilateral transactions, and foreign exchange swap tenders against various types of collateral, including both foreign currency and securities denominated in foreign currency. In each case, the arrangement was between the foreign central bank and the institutions obtaining the funding in these operations. The foreign central banks determined the acceptability of the collateral offered and the eligibility of the institutions to participate in the operations they conducted. The terms on which funds were tendered were released to the public by the foreign central banks. The Federal Reserve’s contractual relationship was with the foreign central bank and not with the institutions obtaining dollar funding in these operations.

What revenues and costs arose for the Federal Reserve?

When a foreign central bank drew on its swap line to fund its dollar tender operations, it paid interest to the Federal Reserve in an amount equal to the interest the foreign central bank earned on its tender operations. For its part, the Federal Reserve did not pay interest and committed to hold the foreign currency that it acquired in the swap transaction at the foreign central bank (rather than lending it or investing it in private markets). The structure of the arrangement served to avoid domestic currency reserve management difficulties for foreign central banks that could have arisen if the Federal Reserve had actively invested the foreign currency holdings in the marketplace.

What was the impact of swaps on U.S. monetary operations?

The drawing of U.S. dollars by a foreign central bank resulted in an increase in the level of reserve balances held at the Reserve Banks. Similarly, the repayment of U.S. dollars to the Federal Reserve when a swap was unwound resulted in a drain of these balances.