Fed Currency Swaps Look Good for the USD

by John Jagerson

The Fed told the world yesterday that they would be extending the currency swap facilities and issuing more USD through the arrangements to most of the worlds largest central banks. A swap is an agreement in which the Fed trades US Dollars for an equivalent value of the other central bank's currency. For example, the Fed may trade $20 billion for 23 billion Swiss francs at today's exchange rate. Why would the Fed do this and what does it mean for the value of the dollar versus the other majors?

EUR/USD (:EUR-USD) Intraday | 3 Month | 6 Month | 1 Year Data as of 02/05/09 07:56 PM EDT Last Trade $1.28 Change (%) 0.00 (0.00%) High 1.28 Low 1.28 Volume 0 Exchange Quotes delayed at least 20 mins.

Trading currency like this is supposed to increase the supply of dollars so that other central banks can auction and distribute them to their own commercial banks. Increasing the supply of dollars should help ease the credit market in these other countries.

This is needed because many commercial transactions around the world are done in dollars rather than the domestic currency so the supply of dollars is a critical component in running a smooth economy. The Fed's actions are largely seen as being very supportive for stimulus plans taking shape around the world and in the U.S. itself.

The injection of dollars in exchange for foreign currency is also very supportive from a fundamental perspective for the USD itself. The dollar has been strengthening in recent months and has begun to channel in a consolidation over the last few weeks. The signal here is that there is still strong demand for USD, which can help traders think about what direction they should be looking for trades.