The unprecedented economic sanctions imposed on Russia in response to its invasion of Ukraine represented a calculated risk. The US, EU and other governments reacted to warnings that their actions could foul the short-term loan markets that underpin global finance.
So far, market participants’ worst fears have not materialized. Measures of short-term borrowing stress have increased, but remain well below levels of past crises, and Federal Reserve facilities put in place during the pandemic to help foreign central banks access dollars have been little used. .
Although it’s too early to tell for sure, investors said the plumbing in global financial markets appeared to be working even as stock and government bond yields fell and the price of oil and other commodities was skyrocketing.
“People are nervous. People are scared right now. There is a rush for funding,” said John O’Connell, portfolio manager at Garda Capital Partners. “But I don’t think it will get out of control.”
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 before falling back to 0.35 percentage points.
It was its highest level since April 2020. But it was still a long way from its peak of nearly 0.8 percentage points in March 2020 or more than 2.1 percentage points during the 2008 financial crisis.
Rates on three-month commercial paper – 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 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 in foreign exchange reserves, including dollars 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 Facility for Foreign and International Monetary Authorities (FIMA) 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 Jay Powell said they were “working well.” He said a “large amount of cash” was running through 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 in public remarks Wednesday that the existence of these liquidity facilities was enough to keep things running smoothly, even if utilization remained low.
“Their presence has also given confidence in the liquidity available and knowing that they are operationally there and standing, I think that has mitigated some of the cautious demand for liquidity that may have emerged amid the heightened uncertainty. that’s emerged in the last few days,” Logan said. .
Bankers also said they were told in advance by Biden administration officials of the possibility of sanctions against Russia’s central bank, allowing them to prepare for the impact.