A Forex View From Afar

Usd/Chf. The Link To The Fed

It is a possibility...

Due to the tight credit conditions in the inter-bank market the Fed had announced new forms of Lending for Financial institutions.

Currently, there are 8 ways of getting money from the Fed, 5 of which were masterminded only after the credit squeeze had begun. We could take this as a sign, showing how strong the financial markets really were affected.

Here are the current main ways for borrowing:


1. Open Market Operations
2. Discount Window
3. Securities Lending
4. (New) August 17, 2007 Term Discount Window Program
5. (New) December 12, 2007 Term Auction Facility
6. (New) March 7, 2008 Single-Tranche OMO Program
7. (New) March 11, 2008 Term Securities Lending Facility
8. (New) March 16, 2008 Primary Dealer Credit Facility


It is well known that Mortgage Backed Securities, or MBS, are the cause of the credit crises, pushing losses in the form of write-downs higher, actually, way up. To counter these the Fed had opened its doors to accept MBS through 7 of its Lending Facilities, as long as they are rated AAA. The only one making an exception is the Securities Lending which accepts only US Treasuries.

One step further, the Term Securities Lending Facility accepts MBS rated as AAA and Residential Mortgage-Backed Security, while the others do not. With this decision the Fed is going one step further in an effort to free up the bank's balance sheets, especially when they are accepting AAA MBS paper with a "hair cut" of only 98%.
This is the same "hair cut" T-bills get and we have to think that the MBS market at this point is completely frozen. This is the best deal you can find out there.

At this point in time us forex traders should start to see an interesting position. The bank switches MBS papers, that they can't sell anyway, for Treasury Bills, which are highly liquid papers. Banks don't just take T-Bills to keep them on the balance sheet, they have their MBS for that; Banks takes T-Bills to sell them, and increase their liquidity. Win/Win for the bank, Lose/Lose for the taxpayer who's money the Fed is playing around with in an effort to stimulate the economy.

By selling T-Bill they are actually sending Bond prices down and Bond yields up (from the bonds price/yield inverted relationship). Sending up the short term interest rate, through selling T-Bills, generally increases the yield on longer term bonds, like the 5 and 10 years bonds. This is how the Fed, as any other central bank does, controls interest rates, by controlling short-term yields.

Obviously, the most effected currency pair by the raise in Bond's yields, especially 10 years Bonds, is the Swissy, Usd/Chf. If this all holds true it would mean we should see some stronger Dollar bounces versus the Swiss Franc.

It is interesting that since the Lending Facility was announced, we have seen a certain increase in T-Bills yields. Unfortunately, the TSLF is still new, with only 2 operations until now. We still need some more time to determine if this theory will work over time, but it's attractive to watch the operations being done, and to monitor its effect on currencies.

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