how the financial system survived the first week of sanctions
“People are nervous. People are scared right now. There is a rush for funding, but I don’t think it will get out of hand,” said John O’Connell, portfolio manager at Garda Capital Partners.
The state of play was highlighted by the movement in a measure of dollar funding stress known as the FRA-OIS spread.
It rose from 0.26 percentage points on Thursday to 0.38 percentage points on Friday (Saturday AEDT) before dropping to 0.35 percentage points.
It was its highest level since April 2020, but still well below its peak of nearly 0.8 percentage points in March 2020, or more than 2.1 percentage points during the 2008 financial crisis.
Three-month commercial paper rates – which allow companies and banks to borrow from investors for short periods – also rose to around 0.6%, but remained well below levels reached when the COVID-19 reached the United States in early 2020.
Another positive indicator came from currencies such as the Mexican peso and the South African rand, which are expected to decline in the event of a severe shortage of dollar funding. They have both been relatively stable.
Markets were tested when governments imposed sanctions on Russia’s central bank, limiting its ability to access around $630 billion ($855 billion) in foreign exchange reserves, including dollars that it would normally be able to lend on the financing markets.
Investors, bankers and analysts said the impact was mitigated by the existence of Fed programs that were put in place during the pandemic to keep dollar funding markets functioning.
The permanent repo facility, made permanent in July, allows US banks to exchange Treasury bills for dollars. The Foreign and International Monetary Authority Facility grants the same privilege to foreign central banks.
The so-called swap lines allow foreign central banks to temporarily borrow dollars. A sign that other countries have been able to access dollars, no foreign central bank had appealed to FIMA on Friday and the use of swap lines remains minimal.
Asked by U.S. lawmakers on Wednesday about dollar funding markets, Fed Chairman Jerome Powell said they were “working well.” He said a “large amount of cash” was circulating in the system.
“Between our swap lines and our repo facility for other foreign central banks and our permanent repo facility in the Treasury market, we have institutionalized the provision of liquidity,” he said.
Lorie Logan, head of the New York Fed’s markets group, suggested that the existence of these liquidity facilities was sufficient to ensure smooth operation, even if utilization remained low.
“Their presence has also given confidence in the liquidity available, and knowing that they are there operationally…I think that has mitigated some of the cautious demand for liquidity that may have emerged in the midst of the heightened uncertainty,” she said.
Bankers also said they were told in advance by US government officials of the possibility of sanctions against Russia’s central bank, allowing them to prepare for any fallout.