US Dollar Gains as Fed Balance Sheet Swells, but it is Not What You Think

Asia-Pacific Market Briefing – First Republic Bank, Fed Balance Sheet

The US Dollar outperformed its major counterparts on Thursday as financial market volatility continued cooling in the wake of last week’s collapse of Silicone Valley Bank. Reports crossed the wires that First Republic Bank, one of the regional lending institutions caught in the storm, was poised to receive about 30 billion of rescue aid from some of the nation’s largest banks.

Front-end Treasury yields rallied, with the 2-year rate soaring almost 7% over 24 hours. This suggests that perhaps some financial uncertainty was taken off the table, opening the door for the Federal Reserve to perhaps continue with its tightening operation to bring inflation down. The Dow Jones, S&P 500 and Nasdaq Composite rallied.

Meanwhile, it was revealed that the Fed’s balance sheet swelled by an impressive 300 billion. Make no mistake, this is not quantitative easing. On the chart below, you can see that while overall holdings rose, securities held outright (mostly Treasuries) and mortgage-backed securities (MBS) continued shrinking as one would expect under quantitative tightening.

Federal Reserve Balance Sheet

Federal Reserve Balance Sheet

What ballooned was discount window lending, soaring to 152.9 billion last week. That was more than what was witnessed during the 2008 Financial Crisis and the 2020 Covid pandemic. Discount window lending primarily serves as a safety valve and an extension of credit to alleviate liquidity strains. It is a separate short-term mechanism from the current medium-term rate hike/QT regime. You can see how temporary it can be in the chart below.

Discount Window Borrowing

Discount Window Borrowing

US Dollar Technical Analysis

Looking at the daily chart, the DXY Dollar Index bounced off the floor of an Ascending Channel that was established back in February. This could open the door to cautious uptrend resumption. Immediate resistance seems to be the 38.2% Fibonacci retracement level at 106.152 as well as the 200-day Simple Moving Average (SMA).

DXY Daily Chart

DXY Daily Chart

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