World’s Central Banks Provide Massive Injection of U.S. Dollar Liquidity

Demand for short-term U.S. dollar funding has spiked in response to the recent financial crisis, sending overnight interbank funding rates up by several percentage points. In addition, funding pressure has moved out the short-term yield curve, with one month LIBOR rates jumping about 200 basis point, to 4.50%, and three-month LIBOR rates up by 85 basis points, to 3.80%.

This spike in short-term LIBOR borrowing rates, unless forestalled by substantial injections of liquidity by the central banks, would be quickly transmitted to consumer and business borrowing rates, thereby exacerbating the credit crunch conditions that already prevailed prior to the outbreak of the most recent crisis last week end.

The Federal Reserve has provided close to $70 billion in liquidity to U.S. domestic markets in the past few days. In addition, the Fed has authorized a $180-billion expansion of its swap lines with other major central banks. This involves increases in the existing swap lines with the ECB and the Swiss National Bank and new swap facilities with the Bank of Japan, the Bank of England, and the Bank of Canada. All of these reciprocal currency arrangements have been authorized through January 30, 2009.