Central banks begin gaming out U.S. default as deadline nears

Fingertips

“The bank has at its fingertips a range of tools to ensure the system operates properly, that liquidity conditions remain normal in all sorts of eventualities,” Bank of Canada Governor Stephen Poloz told reporters in Washington on Oct. 11. He declined to talk about specifics.

The U.S. Federal Reserve opened what eventually became 14 swap lines in December 2007 to provide the global financial system with dollar liquidity as the subprime mortgage crisis began to create doubts about the quality of assets on bank balance sheets around the world. They were boosted as markets froze the following year.

The swaps were closed in February 2010 and re-opened three months later amid a squeeze in dollar funding due to the euro area debt crisis. Last December, the Fed extended the lines with the Bank of Canada, Bank of England, the European Central Bank the Swiss National Bank until February 2014. The swaps allow the central vanks to borrow in dollars from the Fed and then auction them at home.

‘Liquidity Strains’

With less room to cut interest rates now than in 2008, when major central banks did so in unison, a U.S. default would prompt officials to first focus on pumping cash into the financial system, said Stewart Robertson, an economist at Aviva Investors Ltd in London, which has about $438 billion under management.

“There are other measures they can take, such as easing liquidity strains,” said Robertson. “They might actually find that easier than after Lehman. At that time there was really a worry about who was holding billions and trillions of toxic waste. With this, you know more what’s happening.”

While they could utilize swap lines and keep accepting Treasuries as collateral, central banks would probably hold back on easing monetary policy because they would bet the U.S. would quickly end the default once markets turned volatile and recession loomed, said Wood of Berenberg Bank.

“It’s only if you think the default will be extended and politicians won’t react enough that you would engage in significant monetary policy,” he said. “Would you buy oodles more bonds if you expected lawmakers to act?”

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