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Shrinking USD Liquidity to Affect Financial Markets


Posted: Tuesday, August 4th, 2020

Estimated Reading Time: 2 minutes

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The USD took a hit for the month of July 2020, only recovering from its lows last Friday. The EURUSD, AUDUSD, GBPUSD – they all gained multiple big figures against the greenback in July. However, the USD liquidity shrank due to the Fed’s action, making it an interesting August ahead.

The Treasury’s account at the Fed continues to rise, reaching almost $2,000 trillion in July. Effectively, it means that, despite the Fed’s easing, the USD liquidity keeps shrinking.

USD Liquidity

More precisely, while the Fed keeps printing money via its bond-buying program, the Treasury piles more than the Fed issues. Hence, the USD liquidity favors a higher USD – not a lower one.

USD Liquidity Ahead of the Presidential Elections

The Fed made it clear last week that, as an institution, it has lending, not spending abilities. Its swap lines with peer central banks ushered the initial impact of the COVID-19 crisis. Even more, the swap lines continue to operate, acting as a buffer for the financial markets.

The dollar’s decline last month was so steep that many voices wondered if its role as a reserve currency is not threatened. But if history tells us something, it is that the USD share in international reserves rises during economic recessions. Why would this time be different? In fact, it explains the shrinking USD liquidity.

Financial Markets Ahead of the U.S. Presidential Election

The big unknown for financial markets and the USD is the U.S. Presidential election in November. President Trump already hinted at a possible delay – which is literally impossible due to the Congress having all the power to do that.

However, financial markets, in particular the USD and the U.S. stock market, have an interesting way of positioning ahead of elections. If we look back four years ago, the stock market had an indirect correlation with everything positive regarding Trump. Yet, it rallied shortly after his election.

The coronavirus pandemic also changes the playing field. The U.S. Congress offered the spending the Fed could not – Americans received $600 weekly checks to make ends meet. This is likely to continue moving forward, and, in a way, it explains the piling of USD at the Treasury.

In the next five months, the Treasury will short UST worth of $3,000 billion. Besides the Fed, who is going to buy all that issued debt?

So far, the U.S. Treasury had no problems finding buyers for its debt. Moreover, the USD remains the true world’s reserve currency.

If a second COVID-19 wave is underway, the markets may put pressure on investors ahead of the U.S. election day. Without the Treasury unleashing its USD bazooka, the net-net is a positive for USD longs.

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