What’s this mean? It’s actually pretty simple.
Mike O’Rourke of BTIG explains. The Fed will swap dollars for euros, so that the ECB can then provide dollars to dollar-starved central banks:
Among the recent problems in the EU has been that banks there have had trouble gaining access to Dollars to meet the insatiable flight to quality Dollar needs in the EU resulting from this crisis. This is likely the result of U.S. institutions trying to limit their respective exposure to a contagion. As such, the Fed and the ECB will now act as middlemen or clearing houses for the currency exchanges. The Fed will swap Dollars for Euros with the ECB and then the ECB can supply the European banks with the much sought after Dollar liquidity.
Is this a big deal? Yes, and it fact is is a form of monetary easing (and to think just a few weeks ago folks were talking about tightening).
As such, it will likely cap the dollar rally.
As the chart below illustrates, the introduction of this new liquidity through Central Bank swap lines into the system during 2008 provided the supply to meet the excessive flight to quality demand for Dollars, thus creating the currency elasticity the Fed sought. This current move should have a similar influence, capping the recent move of Dollar strengthening for the time being.
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