Thursday, October 30, 2008

Fed has accumulated vast foreign currency holdings in a brief time. Bullish for dollar.

In the past four months the Fed has lent out $522 billion in U.S. dollar loans to foreign central banks, taking on an equivalent amount of foreign currency. This is an enormous increase in foreign reserves held by the Fed. Back in June the Fed only had $38 billion in foreign currency holdings and that’s about the amount it has held for years and years. This has huge implications. Loans between central banks such as this must be repaid. And they must be repaid to the Fed in dollars. Foreign central banks have doled this money out to banks in their respective nations and who knows what these loans are being used for. Furthermore, it is probably safe to assume that some percentage of these loans will not get paid back. (That even happens in good times.) But CBs will be on the hook to the Fed for the entire amount. Ultimately, the only way for foreign CBs to pay back any shortfall is to sell their own currency and buy the dollar. This could underpin the dollar for some time to come. Moreover, if the U.S. government’s attempts to shore up the financial markets and economy succeed, investors will want to own the dollar. A “perfect storm” of dollar bullish fundamentals may be coming together. I am short such currencies as the Hugarian forint, the Polish Zloty as well as the British Pound, Canadian dollar and most important, the euro.

No comments: