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Credit Suisse Sees Funding-Strain Risk Without Fed Liquidity

Credit Suisse Sees Funding-Strain Risk Without Fed Liquidity

(Bloomberg) -- Disruptions to the global supply chain from the coronavirus have sparked the danger of funding strains that could be made worse by steep Federal Reserve interest-rate cuts, according to analysts at Credit Suisse Group AG.

“The supply chain is a payment chain in reverse,” Zoltan Pozsar, an investment strategist at the bank in New York, and economist James Sweeney wrote in a note Tuesday. “The biggest risk we see to the plumbing is the Fed cutting rates aggressively, without pledging an open-ended liquidity support through its balance sheet.”

The greenback accounts for more than 46% of transactions through the SWIFT global payments system, excluding intra-euro region flows, according to its website. The Credit Suisse analysts reasoned that sharp cuts by the Fed would see dollars flow from money market accounts into bonds as the yield curve steepens -- restricting capital needed to address any funding strains.

Credit Suisse Sees Funding-Strain Risk Without Fed Liquidity

“If the outbreak worsens, funding-market pressures can easily escalate,” Pozsar and Sweeney said. “Rate cuts will help, but rate cuts, if they re-steepen the curve materially, can exacerbate funding pressures.”

The duo suggested that the Fed make a pledge to use the foreign-exchange swap lines it has with major developed-nation counterparts, an uncapped repurchase facility and a return to quantitative easing if needed.

Banking Deficit

It’s “not unrealistic” to think that missed payments in the global system could “quickly run up to $200-$300 billion,” they wrote. “A mass drawdown of corporate credit lines due to missed payments could push the U.S. banking system back into deficit in short order.”

“Money funds have absorbed $600 billion of inflows over the past year and rate cuts could send those funds back to the bond market, precisely when the funds are needed in the money market,” Pozsar and Sweeney wrote.

Pozsar in August argued that the Fed needed to lower interest rates further to address a looming funding squeeze exacerbated by foreign central bank demand for its reverse repurchase agreements. It did cut twice more, and later took action to ease a sudden liquidity shortage that market participants attributed to a number of reasons, from a fundamental shortage of bank reserves in the system thanks to Fed quantitative tightening and lenders’ need to meet regulatory guidelines, to a boost in U.S. Treasury cash balances.

The Fed resumed overnight repo operations in September for the first time in a decade, but has rejected a standing repo facility. It also plans to phase out special purchases of Treasury bills that the central bank instituted last year to boost reserves in the financial system.

--With assistance from Tracy Alloway and Gregor Stuart Hunter.

To contact the reporters on this story: Christopher Anstey in Tokyo at canstey@bloomberg.net;Joanna Ossinger in Singapore at jossinger@bloomberg.net

To contact the editors responsible for this story: Christopher Anstey at canstey@bloomberg.net, Cormac Mullen

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