Update on the Fed

Only a week after I complained about the way the Fed was reporting currency swaps on its balance sheet, the Fed has altered its reporting. (Not that I’m suggesting that my post had anything to do with inspiring the change.) The details are in the Fed’s H.4.1 Release for January 29, and as a result, currency swaps are now much easier to track. I will explain how further below, but I first should note another development. The Fed has sold off over $100 billion worth of commercial paper over the last week. So its total balance sheet has dropped again, to $1.93 trillion. The monetary base is also around $100 billion off its peak, leaving it at about $1.63 trillion. Of course, that still represents a near doubling of where the base was four months ago.

As for the swaps, the Fed is now breaking them out from under the category “Other assets” in sections 1 and 8 of the H.4.1 Release into a category of their own, “Central bank liquidity swaps.” One thing that was previously unclear was whether the swaps involved any exchange-rate risk, and if so, how it was booked on the balance sheet. But the Fed now explains that the swaps are unwound at exactly the same exchange rate at which they first take place. If the Fed creates $200 and exchanges it with the Bank of England for 150 pounds, then when the Bank of England is done with the $200, it gets exactly 150 pounds back, irrespective of what has happened to exchange rates during the interval, which can be three months or more. This is one way swaps differ from normal central-bank interventions into foreign exchange markets.

What made this confusing is that the Fed marked to market all its holdings of foreign currency on a daily basis anyway, even those from the swaps. This created no problem for reading the balance sheet if the value of foreign currencies fell, because the Fed put a positive exchange rate adjustment factor into “Other assets,” the total of which would therefore be unaffected on net. But when foreign currencies rose in value, the rise in the value of “Other assets” would be matched by a positive exchange rate adjustment factor on the other side of the balance sheet, in “Other liabilities and accrued dividends.” This meant that any appreciation of foreign currencies would overstate the size of the Fed’s balance sheet until the offending swaps were unwound. Fortunately, the Fed has discontinued this balance-sheet oddity. It will now book “Central bank liquidity swaps” at the originating exchange rate throughout their duration.

Not that this has removed all of the balance-sheet mysteries surrounding the Fed’s currency swaps. They continue to mainly show up on the liability side not as foreign deposits at the Fed but as Treasury deposits, and I’m still not entirely sure how this works in detail.