HomeUSD Liquidity Hitting Financial Markets

USD Liquidity Hitting Financial Markets

Enormous excess liquidity is coming from the United States in the next few months, equal in size, or maybe even bigger, with the one seen in April 2020 and the months that followed. Back in April last year, in response to the pandemic, the Fed opened USD swap lines with the major central banks in the world. 

The move, coupled with fiscal and monetary easing, led to one of the sharpest declines in the U.S. dollar in the last years. For example, the EURUSD pair rose from 1.06 to 1.23, a move mirrored by all G10 currencies against the dollar.

We may say that the liquidity “bazooka” that is about to come is at least strange at this stage. After all, the U.S. economy is starting to give signs of recovery. Plus, the success of the vaccination campaign signals even more positive economic data further down the road.

However, Nordea, a European investment bank, suggests three sources of excessive dollar liquidity in the months ahead. One is the continued Fed QE bond-buying, with the pace of $120 billion/month. Another is the U.S. Treasury being forced to wind down the TGA (Treasury General Account). Finally, the debt ceiling coming into effect on August 1st will force the Treasury to draw down even more funds from its account parked at the Fed.

Will the Dollar Trend Lower Again?

The logic will tell us yes. After all, when the supply exceeds the demand, the price of a good or service declines – the same with the dollar.

However, this time might be different for at least a few reasons. First, long yields in the United States are surging. This is the main theme in financial markets and it signals the investor’s willingness to get out of the stock market as the yield on long-term bonds exceeds the dividend yield on stocks. Moreover, bond yields are not taxable – another incentive to get out of stocks. Lower equities are good for the dollar, at least if we judge by the reaction we’ve seen so far in the markets.

Second, if the stock market sell-off intensifies, we may also see risk-off movements. That is, strong JPY, CHF, and USD.

Finally, all of the above are no secret to financial markets. Therefore, if we assume that everything is already priced, as efficient markets do, then why is the dollar still strong?

Join the Social Trading revolution. Connect with other traders, discuss trading strategies, and use our patented CopyTrader
eToro is the world’s leading social trading platform, offering a wide array of tools to invest in the capital markets
Largest number of currency pairs to trade
Open my Account

We use cookies to personalise content & ads, provide social media features and offer you a better experience. By continuing to browse the site or clicking "OK, Thanks" you are consenting to the use of cookies on this website.