US dollar funding tensions and central bank swap lines during the COVID-19 crisis

This box provides evidence on the positive impact of the Eurosystem’s US dollar-providing operations on the functioning of the EUR/USD foreign exchange (FX) swap market, using ECB Money Market and Statistical Reporting (MMSR) transaction data. In the context of high market volatility and risk aversion due to the coronavirus (COVID-19) pandemic, US dollar funding conditions tightened notably from the end of February 2020, when supply-demand imbalances led to a deterioration of liquidity conditions and eventually a surge in US dollar funding premia. The enhancement of the central bank swap lines on 18 March, by introducing a new 84-day US dollar operation in addition to the existing 7-day tender and lowering the price of all US dollar operations, brought significant relief to the short-term US dollar funding conditions. However, the relief was short-lived and it was only with the introduction of daily operations on 23 March that conditions improved in a sustainable manner and across all maturities, as uncertainty about US dollar availability abated. Once US dollar funding conditions started to normalise, the Eurosystem’s US dollar operations gradually lost their appeal, as seen in the significant drop in participation. This box shows that the Eurosystem’s US dollar operations not only helped banks to satisfy their immediate US dollar funding needs but also supported market activity, as banks participating in the US dollar operations became more willing to intermediate and passed funds borrowed from the Eurosystem on to other market participants. This in turn contributed to the normalisation of US dollar funding conditions and highlights an important transmission channel of the central bank swap lines. JEL Classification: E5, E4, G1, D53