By Jamie McGeever
ORLANDO, Florida (Reuters) -TRADING DAY
Making sense of the forces driving global markets
By Jamie McGeever, Markets Columnist
Wall Street fell on Wednesday as record high prices and lofty valuations gnawed away at sentiment, while the dollar rose as investors continued to digest Federal Reserve Chair Jerome Powell’s cautious comments this week on further rate cuts.
In my column today I look at whether the apparent politicization of the Federal Reserve and growing concern about its independence will extend to dollar swap lines, its liquidity lifeline to other central banks in times of crisis.
If you have more time to read, here are a few articles I recommend to help you make sense of what happened in markets today.
Today’s Key Market Moves
Today’s Talking Points:
* Always take the Tether with you
El Salvador-based crypto giant Tether is in talks to raise as much as $20 billion in a private placement that could value the firm at $500 billion, according to Bloomberg News. These are big sums, and raise big questions.
A valuation that size could be a game-changer for many crypto skeptics, forcing them to finally invest in the rapidly growing market. But if Tether is so profitable, why does it need that much fresh funding? And is it really worth the same as Goldman Sachs and Morgan Stanley combined?
* Signs of life in the dollar?
The dollar rose to a two-week high on Wednesday, clocking its biggest rise in three weeks. It is welcome respite for the battered currency, which last week traded at its weakest level against a basket of major currencies since February 2022.
But the dollar is hardly out of the woods. Its short-term technical outlook is dim, and a lightening of short positions in recent weeks suggests traders have scope to get bearish again. Bulls’ best hope may be the number of implied Fed rate cuts this year in the rates futures curve falling to one from two.
* Slick oil
Oil prices leaped as much as 3% on Wednesday, their best day since July, as a surprise drop in U.S. crude inventories added to a sense in the market of tightening supplies amid export issues in Iraq, Venezuela and Russia.
Brent crude is now nudging $70 a barrel instead of looking to break below $60, as had seemed more likely a few weeks ago. The disinflationary effect of oil prices is fading. Prices are now only 6% down from a year ago, compared with almost 30% in April.
Fed independence spotlight shines on dollar swap lines
Debate around politicization of the Federal Reserve has mostly centered on its interest rate-setting independence. But another part of the central bank’s toolkit, with perhaps even greater significance for global financial stability, is back in the spotlight: dollar swap lines.
These are the pipelines of dollar liquidity to central banks that the Fed opens in times of crisis, like 2008 and 2020, to keep the dollar-based global financial system from seizing up. Ultimately, when the world needs scarce dollars, the Fed assumes its role as lender of last resort and provides them.
That’s the assumption. Or the hope.
The Fed has standing dollar swap lines with five major central banks – the European Central Bank, Bank of Japan, Bank of England, Swiss National Bank, and Bank of Canada. It has since retired the temporary lines opened in the 2008 and 2020 crises with central banks in nine other countries that included Brazil, Australia, and Mexico.
The use of this instrument seemed fairly uncontroversial. It is a critical tool in preventing severe tightening of financial conditions, disorderly dollar strength, and broader market turmoil in times of global stress.
But as with many aspects of the economic status quo since President Donald Trump’s return to the White House, that can no longer be taken for granted. It may increasingly be used as a political tool as much as a financial and economic one.
‘A HIGH-LEVEL POLITICAL MATTER’
Will a Trump-influenced Fed automatically lend dollars to foreign central banks in a crisis? It might lend to some without hesitation, but not all. Current events with the U.S. vis-a-vis South Korea and Argentina shine a light on the politics at play.
Seoul reached a preliminary trade deal with Washington in July but has not yet signed it due to the foreign exchange implications of a $350 billion investment package included in the deal.
“My personal opinion is that the FX swap is a high-level political matter, not an economic one,” Bank of Korea board member Hwang Kun-il said on Tuesday. A day earlier, President Lee Jae Myung told Reuters that the economy could fall into a crisis rivaling its 1997 meltdown if it accepts Washington’s demands without safeguards, such as a currency swap.
Meanwhile, U.S. Treasury Scott Bessent on Monday said “all options”, including a currency swap line, are on the table to stabilize Argentina’s markets, which are once again suffering a severe crisis of confidence. Bessent stressed that Washington’s support for right-wing President Javier Milei, Trump’s biggest ally in Latin America, will be “large and forceful”.
Of course, a dollar swap line may be offered to South Korea, the sixth-largest U.S. goods trading partner last year and which boasted a $66 billion surplus. And Treasury can operate its own swap lines under its Exchange Stabilization Fund.
But the administration’s approach to the two countries is clearly different.
This is not just an emerging market issue either. The Bank of England and European Central Bank have asked lenders to assess their need for dollars in times of stress, and weigh up their options if they’re unable to rely on the Fed backstop.
POLITICAL ALIGNMENT AT PLAY
As Bank of America analysts noted in a report last month, only the Federal Open Market Committee or Congress can make changes to FX swap lines, which are managed by the New York Fed under authorization of the Fed itself. “The executive branch has no direct authority to make any changes,” they wrote.
But pressure on the Fed from the administration, often from Trump himself, is intensifying and taking many forms. Not only has the White House demanded that interest rates be slashed, it is attempting to fire Fed governor Lisa Cook, and has got current White House adviser Stephen Miran onto the Fed board.
So while the president doesn’t have direct authority over the Fed’s dollar swap lines, it’s another area where the administration could exert its influence “via moral suasion as well as the appointment of the Fed governing board,” as Deutsche Bank analysts wrote in a report in March.
Perhaps this was always the case. John Michael Cassetta, author of a working paper “The Geopolitics of Swap Lines” published in 2022 by the Kennedy Business School, posited that although it was never explicitly stated, politics influenced the Fed’s choice of who got swap lines in 2008 and 2020.
“The empirical evidence suggests that, controlling for other potential factors, political alignment with the U.S. played a role in determining a country’s likelihood of receiving a swap line and where it placed in the hierarchy,” Cassetta argued.
There is also evidence to suggest that political pressure on the Fed has increased significantly since then.
What could move markets tomorrow?
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Opinions expressed are those of the author. They do not reflect the views of Reuters News, which, under the Trust Principles, is committed to integrity, independence, and freedom from bias.
(By Jamie McGeever; Editing by Nia Williams)
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