Today’s news of coordinated action by the major central banks to reduce the cost of FX swaps by 50bp and extending the program’s authorization until February, 2013 certainly captured the market’s attention. The Fed announcement is here. The dollar strengthened, stock markets rallied, and there was a general sigh of relief heard around the globe. Reducing the cost of borrowing isn’t, unto itself, very meaningful. But there were two strong signals sent by the action: 1.) the central banks are paying attention and aren’t afraid to come together to act and 2.) by taking this action, foreign banks who need dollars to fund themselves have a backstop.
This is very important to the repo and securities lending world. Cash lenders have been pulling back on their European exposure. According to the New York Times, American money market funds have reduced exposure to French financial institutions by 69%. Where securities financing is concerned, cash lenders can rest easier knowing that their foreign bank counterparts can pay off their loans by tapping their central banks for dollars.
Post-Lehman Brothers, the Fed did something very similar with the Primary Dealers Credit Facility (PDCF) and Term Securities Lending Facility (TSLF). It wasn’t how much the facilities were used or what they cost that was important – it was that they could be relied on to take out the cash lender at maturity if it came to that. The PDCF, in particular, was viewed as arresting the systemic risk embedded in tri-party repo. If the impact of cheaper, more plentiful FX swaps is to restore confidence that loans will be repaid when due – mitigating rollover risk — we’d say that is a very good thing.