An employee wearing protective gloves counts US banknotes at a currency exchange in Jakarta, Indonesia. Global demand for dollars has eased off.
Demand for US dollars has declined as strains in the global financial system have eased © Bloomberg

Four of the world’s leading central banks have further scaled back the US dollar liquidity they offer via emergency swap lines with the Federal Reserve, in the latest illustration of the global financial system’s recovery from the market panic caused by coronavirus earlier this year.

The European Central Bank, the Bank of England, the Bank of Japan and the Swiss National Bank said on Thursday that they would offer short-term dollar funding via the Fed’s swap lines only once a week, instead of three times, because of “continuing improvements in US dollar funding conditions and the low demand” at recent auctions.

This is the second time central banks have scaled back their efforts to channel dollars cheaply into their domestic economies. In June they cut back the auctions from every day to three times a week.

“The decision is a signal of the success of these operations,” said Kamakshya Trivedi, a currency strategist at Goldman Sachs in London.

The US central bank reinstated the swap lines in March for the first time since the financial crisis, after global demand for the greenback surged in the early stage of the pandemic and sent the currency’s exchange rate surging. To soothe the markets, the Fed provided overseas central banks with dollars directly in exchange for their local currency.

The intervention played an important role in slowing the surge in the dollar’s exchange rate and easing the sell-off in equity markets.

Line chart of Outstanding loans via US Federal Reserve dollar swap lines, $bn showing Demand for dollars has fallen

Since its peak in March the dollar has fallen about 12 per cent against a trade-weighted basket of currencies, according to Bloomberg, and it has slumped to its weakest level since 2018 against the euro.

“The mere existence of precautionary liquidity arrangements has a calming effect on investors,” said ECB executive directors Fabio Panetta and Isabel Schnabel in a blogpost earlier this week. “This measure eventually improved market sentiment, resulting in a considerable drop in the costs of US dollar funding.”

As the strains in the global financial system have eased, demand for US dollars has fallen. The total value of swap line loans outstanding from the Fed has dropped from a peak of $449bn in May to below $100bn — mostly lent to the Bank of Japan.

The ECB had no bidders for six of the nine short-term dollar liquidity operations it has conducted since the start of this month. The Bank of England has not had any outstanding loans from the Fed’s facility for almost a month.

Mr Trivedi said the cost of accessing short-term dollar funding had normalised in both emerging and developed economies, making it likely that the use of the facility would be tapered further in the coming months.

The central banks said they would continue with their weekly offers of US dollar liquidity with 84-day maturity. They added that they “stand ready to readjust the provision of US dollar liquidity as warranted by market conditions”.

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