As the Federal Reserve is widely expected to raise the federal funds target rate (the rate banks charge each other for short-term loans) up 0.25% (25 basis points), you can expect nearly every asset class globally to be affected. But while asset prices adjust globally, the US Federal Reserve has a unique advantage in the global financial system – growing influence over monetary policy worldwide, increasing income generating muscle, and a progressively stronger dollar. Some may call it, “The Fed Factor.”
While the Bank of England has historically moved their rates in tandem with the Federal Reserve, political divergence and growing inflation in the UK will most likely grieve any plans the Bank of England had to raise interest rates. With the Bank of England, Bank of Japan, European Central Bank, and the Swiss National Bank all either practicing a negative or near zero interest-rate policy, investors around the world will likely line up to take advantage of the world’s safest securities – U.S. Treasuries. Though many journalists, academics, and financial gurus are frothing to tell you what impact this will have on YOU, we thought of it a different way – what impact does this have on the Federal Reserve?
Since 2010, the Fed’s balance sheet shows an 80% increase in accrued interest receivables, up to $25.6B in 2014 alone. In May of 2010, the Fed reestablished liquidity swap lines with foreign central banks in order to supply short-term funding to central banks worldwide. The Feds latest report (Nov. 2016) shows one liquidity swap equaled $3.5B with the European Central Bank, loaned at a “market-based interest rate” of 0.91% (91 basis points) for a 7-day term. While depository institutions borrow from the Fed at the federal funds rate to meet demand, it isn’t the only place to go for short-term loans. Banks that operate overseas can also trade Eurodollars at the London Interbank Offered Rate (LIBOR), but with LIBOR double the effective federal funds rate, it is not a likely source of cash for U.S. banks.
In addition, undoubtedly more cash will flow into financial institutions denominated in U.S. dollars because of the higher income generating potential those funds will have in the U.S., but because of capital requirements on U.S. banks, more liquidity will need to be kept with the U.S. Federal Reserve. The Fed will use that liquidity to potentially further increase interest receivables, and elevate the amount of U.S. dollar financing through liquidity swap lines with foreign central banks at favorable rates to the Fed. Although the Fed may raise the federal funds rate further, it will likely remain at historic lows in order to further capitalize on the Feds growing global financial sway.
However inadvertent the Fed was in orchestrating their influence, it will be difficult to unwind. Their large balance sheet, sizable accrued interest receivables, high liquidity swap rates, and intensifying regulatory authority on U.S. banks, make the Fed an ever more dominant part of the global financial system. With 2-year Treasury rates inching above 1.11%, the highest levels in 6 years, and LIBOR above 1.60%, U.S. banks will likely turn to the Fed for short-term lending, which will centrally position the Fed further into the global financial system.