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The Federal Reserve’s “temporary” dollar swap lines with other major central banks are beginning to look like anything but temporary. The facilities were first introduced in December 2007, closed in February 2010, reopened in May 2010, and recently extended through August 2012. Under these agreements, the Fed offers unlimited dollar liquidity to other central banks, which in turn offer the funds to local banks that find it difficult to borrow in interbank markets.
The “re-emergence of strains in short-term US dollar funding markets” was cited by the Fed when it revived the programme last year after its brief hiatus. The recent extension of the swap lines—previously scheduled to expire next month—suggests that officials believe that these strains remain, or may be worsening. But so far the move looks like more of a precaution than a sign of imminent distress. Since announcing the extension on June 29th, no central bank has drawn on the facility (the data is reported weekly, on Thursdays). In fact, the swap lines have not been used since March, when only US$70m was drawn, a small fraction of the hundreds of billions borrowed during the depths of the crisis following the collapse of Lehman Brothers.
Our latest global forecast, published today (free registration required), sees global growth expectations little changed from last month. However, rising inflationary pressures—fuelled by soaring commodity prices—will bring about interest rate hikes sooner than we previously expected.
Namely, the Bank of England is now expected to raise its policy rate in the second quarter of this year. Inflation in the UK has run above the central bank’s 2% target for 14 consecutive months, and we expect it to approach 5% in the next few months. The European Central Bank is now forecast to raise its benchmark rate in the first quarter of 2012, instead of later in the year, for similar reasons.
The US Federal Reserve, by contrast, will keep rates at rock-bottom levels until the second half of 2012.
As Bernanke and company gather in Washington today and tomorrow to assess the strength of the US economy, there is some encouraging news from the country’s banks. Business lending grew at almost an 8% annualised clip in December, according to recent data. This, however, is unlikely to affect the Fed’s policy stance, with no change expected to the US$600bn asset-purchase programme or near-zero policy rates.
What’s more, the month-on-month annualised jump in business loans in December doesn’t tell the entire story. Year on year, the stock of commercial and industrial lending fell for the twentieth consecutive month in December. The ratio of banks’ cash to business loans, although down from recent all-time highs, remains elevated in historical terms.
Recent data on lending, spending and—later this week—overall economic growth in the fourth quarter will give some comfort to American policymakers. However, the recovery has much longer to run. A Fed rate hike is unlikely before the second half of 2012.
Central banks in Europe began to offer unlimited dollar liquidity today, as part of the recently re-activated swap line with the US Federal Reserve (see yesterday’s post for details). The results of the auctions suggest that short-term liquidity problems may be limited to the euro zone, for now.
The European Central Bank received seven bids for the eight-day, 1.22% fixed-rate funds. It allotted US$9.2bn in total. The Bank of England and Swiss National Bank offered the same terms but didn’t receive any bids.
In response to the “re-emergence of strains in US dollar short-term funding markets in Europe,” today the Federal Reserve reactivated liquidity swap facilities with central banks in the euro area, UK, Switzerland, Canada and Japan. Announced alongside the €750bn support package unveiled by officials in the European Union, banks’ share prices soared.
The Fed’s facility allows foreign central banks to provide dollar-denominated financing directly to local banks. When interbank lending markets seized up during the depths of the credit crunch, the Fed established swap lines with 14 other central banks. At its peak in December 2008, outstanding swaps were worth more than US$580bn, or around 25% of the Fed’s total assets. (This handy primer from the New York Fed, highlighted by Real Time Economics, explains the history and mechanics of the facility.)
The Fed’s facility was launched in December 2007 and closed in February 2010. It will reopen tomorrow and the take-up by central banks will be closely watched. Signs of stress in interbank lending markets suggest that banks are growing more wary of lending to each other, bringing back bad memories from the months following the collapse of Lehman Brothers.
“The increase was primarily due to increased earnings on securities holdings during 2009.” This is the rather mundane way in which the Federal Reserve, America’s central bank, explains a US$14.4bn increase in its latest annual profits.
Every year, the central bank transfers the bulk of its net income—earned via interest and dividends from the securities it holds—to the US Treasury. The amount the Fed paid the Treasury in 2009, US$46.1bn, is the largest annual transfer in the history of the bank.
Although the mountains of securities that the institution acquired in order to prop up ailing financial firms are useful earners for now, the central bank may not recoup its principal when it eventually offloads assets to shrink its US$2trn balance sheet. This may explain the low-key approach to its earnings announcement. As an observer notes in the LA Times, “Any other entity that had record profits would have hired a band or had a parade.”
As sometimes happens at the Economist Intelligence Unit, a casual chat around the teakettle in the office kitchen veered from the weather to a serious debate about monetary policy—specifically, the timing of the first Fed rate hike.
Officially, the EIU forecasts that the US central bank will begin to raise rates in the third quarter this year, with its key policy rate reaching 1% by the end of 2010, from a current target range of 0-0.25%. As the tea steeped, assorted analysts and editors mulled the cases for earlier or later hikes.
Instead of a chart, today’s post serves as a pointer to follow the action in August 2010 futures contracts on the federal funds rate after tomorrow’s closely-watched employment report is released. The strength of economic recovery will, naturally, guide central bankers’ policy decisions. Futures markets are currently pricing in a good chance of a hike at the Fed’s August meeting, so trading in that month’s contract will be telling. Roughly speaking, the lower the settlement price, the greater the probability of a hike. (An explanation of how to predict interest rates from futures prices can be found here.)