Fed urged to consider upsizing FIMA

However, this is not strictly the purpose of FIMA. Instead, it appears to be another attempt by the Treasury to ensure that there's no diminution in the demand for treasuries. In our view, such attempts won't make up for the fact that debt dynamics are very poor and that treasury yields will continue to rise.

In the Fed's own words, the purpose of the FIMA facility is to “help address pressures in global dollar funding markets that could otherwise affect financial market conditions in the United States. Its role as a liquidity backstop also helps to support the smooth functioning of financial markets”. Steven Barrow, Head Strategist of the Standard Bank, said that does not sound to us like a facility that's designed to aid FX intervention although we don't deny that it can be used for this purpose. To take a step back for a moment, the FIMA facility allows eligible central banks to repo their treasury holdings into temporary dollar deposits at a penal interest rate.

The Bank of Japan, or any other eligible central bank with treasuries, can clearly use the FIMA to generate dollars which can then be sold for the yen (or other currencies) , avoiding the need for the BoJ or any other central bank to sell their treasury holdings. This last part is clearly the part that Bessent is most interested in. That's understandable in many ways. The US is looking to help support Japan in its intervention to prop up the yen but, in doing so, it should not jeopardise its own financial stability; something that could happen if the BoJ were to conduct large treasury sales.

“The Fed's data on its custody holdings of treasuries for foreign official institutions (mostly central banks) has fallen fast in recent years. Central bank diversification into other currencies and, more notably gold, has been an ongoing theme. It might even be that the introduction of FIMA in 2020 has allowed some central banks to lighten their treasury load. But whatever it is, it seems that the US Treasury is mindful of the risks going forward," Steven Barrow shared.

Of course, other sources of treasury demand exist, notably the private sector, but central banks tend to hold treasuries for the long haul while certain sections of the private sector can be more flighty and so create unwelcome volatility. Encouraging the use of the FIMA facility, which appears to have been done here by Bessent, is not the first time that the Treasury has sought to ensure funding for the treasury market.

Stablecoins are another tool that the Treasury has promoted to ensure a steady stream of demand for treasuries, at least at the front end of the curve in terms of treasury bills. At present, stablecoin issuers only hold around 2-3% of outstanding treasury bills but with Bessent claiming that the stablecoin market can grow by tenfold by the end of the decade he seems to be counting on treasury bill demand to grow by tenfold as well.

While it is laudable that the Treasury is seeking ways to ensure that treasury demand stays robust, there is clearly a nagging concern that this covers up for the fact that little is being done to reduce the supply of treasuries through reducing debt. The current ratio of debt held by the public to GDP is around 100%, and the bi-partisan Congressional Budget Office (CBO) estimates that this will rise to 175% over the next thirty years on current policies. The next requirement to lift the USD41.1tr debt ceiling is likely in just over a year's time. On this, the President continues to push for the debt ceiling to be eliminated, and this even has support from prominent Democrats, such as Elizabeth Warren.

She argues that it should be scrapped because it “primarily poses the risk of an avoidable economic crisis”. While that is the case, there's also an economic crisis risk from not doing anything about the rise in debt. Relying on stablecoin-driven treasury demand and protecting treasuries from central bank sales through FIMA might buy time, but little else.