MNI INTERVIEW: Fed Firm On Swap Lines, If Independent - Sheets

The Federal Reserve will continue to support the market and other countries with dollars through its international swap lines during times of market stress as a core tool of its monetary policy toolkit, so long as the U.S. central bank remains independent, the former director of the Division of International Finance at the Fed Board of Governors, Nathan Sheets, told MNI. 

"The Fed very much views those swap lines as very much a tool that's monetary policy and as part of and protected by its independence," he said in an interview. "It would scream bloody murder if something happened or they were leveraged on the swap lines."

"The White House can't just say they're done. It would be much more complicated than that. So, I don't think they're in jeopardy," said Sheets, who was involved in helping establish and manage the U.S. dollar liquidity swap lines with foreign central banks during the Global Financial Crisis. 

CAVEAT

But "the one caveat on that is that Trump is going to be able to appoint a number of members of the [Fed] board over the next few years," Sheets said. "If he gets people that are against them, maybe they can turn the tables and not renew them."

"And that's fair for a new FOMC to come in and say that, but that would take time. It would be a Fed policy decision, but I think it's protected by its independence. And I don't think that Trump is inclined to blow up the Fed's independence."

In the 2008 and 2020 panics, the Fed provided dollar liquidity to help smooth strains in funding markets. Swap line usage reached as high as USD598 billion in 2008 and USD449 billion in May 2020, stabilizing global dollar markets with most usage coming from the ECB and BOJ. The lines were converted into standing facilities in 2013 and the New York Fed's FIMA repo facility was established in 2020 and converted to a standing facility in 2021. 

"What we're seeing in the markets now would be mild compared to what we'd see if the president went down that path" on Fed independence, said Sheets, who isn't expecting Fed Chair Jerome Powell to be fired by Trump before the end of his term in May of next year. (See: MNI INTERVIEW: Trump Accelerating Dollar Decline - Eichengreen)

"Why do you want to fight that fight and shake everything up when you're going to have the Fed anyways in a year?" 

A FEW CUTS 

The Fed will likely avoid rate cuts for the foreseeable future because the shock from tariffs could boost inflation at a time when it’s already above target and the outlook continues to be very uncertain, said Sheets, now global chief economist at Citigroup. (See MNI INTERVIEW: Tariffs Put Fed In Stagflationary Bind - Ex-CEA)

"My view on this is that this falls into the kind of the broad class of, what do you do in the face of a supply shock? And you hold your breath and hope for the best."

"It's reasonable" the Fed could cut two or three times this year if economic growth slows to around 0.5% as a baseline with some upward pressures on prices, he said. "If we did see a crack in the labor market or a break in the labor market then the scenario the Fed moves much more aggressively, around 200 basis points." 

"If there's any good news for the rest of the world it is that it is much more of an adverse demand shock abroad," he said. "The policy prescription is very clear in kind of putting that together, the central banks at least have a door to be aggressive in providing support without this policy conflict that characterizes where the Fed is. But this is a big global shock."