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Analysts at Nordea Markets suggest that one interesting question is why it took so long before the dollar picked up speed this year, while e.g. surprise indices and equity market movements suggested the dollar ought to gain as per usual patterns,  EUR/USD was stable and range-bound until mid-April, when something in the global financial system seems to have happened.

Key Quotes

Since mid-April, USTs in custody on behalf of foreign agents (a proxy of EM FX reserves) are down by some 70bn.  A negative shift in US excess liquidity momentum has led to weaker EM FX reserve growth in the past: when the Fed “unprints” money, EM FX reserves tends to drop.”

“We can first conclude that Fed’s earlier balance sheet expansion had an outsize impact on foreign banks’ cash holdings.”

As a result of the Fed’s unprinting of US excess liquidity, the pool of super-safe cash assets will dwindle  (unless the Treasury starts to issue a lot of T-bills).”

“If demand for US cash assets from these banks is inelastic, the Fed’s unprinting might cause asset deflation  as these banks sell other assets to rebuild cash buffers.”

“Are SOMA redemptions causing dollar strength and risk aversion?

  • The Fed is gradually letting its balance sheet shrink at a quicker and quicker pace, with a maximum shrinkage of USD50bn/month reached in Q4, 2018 (of which 30bn can be bonds and notes).
  • On some days, liquidity shrinks a lot, most other days, not at all.  From the maturity profile of the Fed’s bond portfolio (the SOMA portfolio) we know when these negative liquidity impacts will take place.
  • For those interesting in really short-term moves on financial markets, we like to point out that  the three most recent redemptions has coincided with dollar strength and weaker risk sentiment.  This is the mirror image of past “POMO days”, when Fed added liquidity to the system.
  • The next big redemption day is May 31, when 28.5bn comes due –  a Sumo SOMA day!  US excess liquidity will shrink almost 10bn. A similar amount came due in mid-May, when the dollar moved 0.7% higher and the S&P500 moved 0.7% lower. Will we see a repeat? Time will tell.”