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US Opens Swap Lines

The Federal Reserve issued the following statement on March 19, 2023 publicizing their action of opening swap lines.

"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 a coordinated action to enhance the provision of liquidity via the standing U.S. dollar liquidity swap line arrangements."

Under this swap lines arrangement, the central banks of Canada, Japan, Switzerland, and the EU could borrow unlimited amounts of US dollars at the going market rates so as the dollars helped stabilized their markets.

How do swap line work?

Let's take an example of the US and Canada's central bank to understand how swap lines work. If The Bank of Canda needs $100 billion US dollars on emergency, they sell equivalent amount of Canadian Dollars at a going exchange rate (eg: 1 USD = 1.32 CAD) to the Federal Reserve, the US central bank. They specify how long they'll borrow it for, maximum borrowing time being 3 months. At the end of the period, they return the US Dollar borrowed at the same rate they agreed on earlier, in this case, 1 USD = 1.32 CAD. Finally, they pay the interest on the amount borrowed for the time period they borrowed it for at the going bank-lending rate. A detailed explanation is pulled from the Federal Reserve's website.

When a foreign central bank draws on its dollar liquidity swap line with the Federal Reserve, the foreign central bank sells a specified amount of its currency to the Federal Reserve in exchange for dollars at the prevailing market exchange rate. At the same time, the Federal Reserve and the foreign central bank enter into an agreement for a second transaction that obligates the foreign central bank to buy back its currency on a specified future date, which could be the next day or as much as three months later, at the same exchange rate used in the initial leg of the transaction. Because both legs of the transaction are conducted at the same exchange rate, the recorded value of the foreign currency amount is not affected by changes in the market exchange rate, and the Federal Reserve bears no exchange rate risk. At the conclusion of the second leg of the transaction, the foreign central bank pays interest to the Federal Reserve on the dollars drawn.

Why did the Federal Reserve open swap lines?

The Swap Lines are one of the tools of the Federal Reserve to maintain dollar liquidity across the world. To that efffect, The swap lines were a critical effort by the Federal Reserve to prevent the regional bank failures in the US from speading on a contagio fashion.

March was the month of mayhem on the financial markets as regionals banks in the US were collpasing one after the other. On the eve of their failure on March 10, 2023, Sillicon Valley Bank (SVB)held more than $209 bn in assets and customer deposits exceeding $175 billion. Within two days of SVB collapse, Signature Bank, a regional bank in New York with $110 billion in assets and more than $88bn in customer deposits collapsed.

Central Banks' Borrowing Activity

The New York FED has a liquidity swap tracker detailing the dollar amounts borrowed by central banks at prevailing interest rates. The swap lines are used effectively and regularly by the Euorpean Union with weekly borrowings of hundreds of billions of dollars. The Swiss National bank borrowed amounts exceeding $100 billion for two weeks following the announcement.

Stock Market Returns Since March 2023

S&P 500 Returns

SPY has recoded an impressive 14% return since March 19, 2023

Nasdaq 100 Returns

The tech-heavy Nasdaq sector has recorded an even more impressive 20.2% run since swap lines began.

Nasadq-100 (QQQ) Returns Since Swap Lines Opened

A New Bull Run?

This is not a financial advice.

There has been an impressive upwards run on the American stock market since swap lines opened. A couple of banks collapsed, deposits were insured, a few panic points were seen across the globe and the FED rushed in offering unlimited dollars. American companies are enjoying impressive profits, thanks to all the American innovation and productivity. NVIDIA is a new entrant to the trillion dollar market cap.

There are now 5 American companies with more than a trillion dollar valuation, namely, Apple, Microsoft, Google, Amazon, and NVIDIA.