FED MEASURES: WHICH IMPACT ON USD LIQUIDITY OVER THE MEDIUM TERM?

Slightly more than one month has passed since the worst liquidity crisis experienced by the Treasuries market since 2008 and the Federal Reserve reverting to an anti-recession stance. In seven weeks, it is no less than $2,331bn of liquidity that has been injected into the system (with at least further $2,300bn primed based solely on the size of the loan facilities established to support the economy) and no less than a dozen exceptional measures that have been taken to support the markets that are key for $ funding. This avalanche of liquidity (even before all facilities are up and running) paid off, preventing a liquidity crisis. Many of the indicators for monitoring systemic risk (see our ad-hoc publication) have headed in the right direction in recent weeks. A sign that the worst appears to be behind us, the New York Fed’s SOMA desk has slowed the pace of asset purchases and reduced the frequency of its repo operations. This episode did, however, reveal frailties in the money markets, notably the importance of regulatory constraints and the pivotal role of money market funds. Nevertheless, one need look only at the evolution of the Federal Reserve’s balance sheet to understand that these temporary measures risk having permanent effects. In the wake of the 2013 announcements and the ensuing taper tantrum, it was five years before the Federal Reserve actually started shrinking its balance sheet, only to be forced to slam on the brakes 18 months later. It is therefore timely to provide an update on current $ liquidity and consider the extent to which the various facilities will become permanent features